Your Firm Is Currently 100% Equity Financed

question 9

Multiple Choice

Your firm is currently 100% equity financed.The CFO is considering a recapitalization plan under which the firm would issue long-term debt with an after-tax yield of 9% and use the proceeds to repurchase some of its common stock.The recapitalization would not change the company's total investor-supplied capital,the size of the firm (i.e. ,total assets) ,and it would not affect the firm's return on investors' capital (ROIC) ,which is 15%.The CFO believes that this recapitalization would reduce the firm's WACC and increase its stock price.Which of the following would be likely to occur if the company goes ahead with the recapitalization plan?

• A) The company's net income would increase.
• B) The company's earnings per share would decline.
• C) The company's cost of equity would increase.
• D) The company's ROA would increase.
• E) The company's ROE would decline.

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Definitions:

Breach of Contract

An act of failing to fulfill the duties, terms, or conditions stipulated in a contract, which may result in legal action or penalties against the offending party.

Liquidated Damages

refers to a predetermined sum agreed upon by the parties to a contract, to be paid as compensation in case of breach of contract.

Exemption Clause

A contract term that attempts to limit or exclude liability for certain events or damages.

Deposit Forfeiture

A legal or contractual process wherein a deposit made as part of a transaction is lost due to non-compliance with the terms of the agreement.