Kaylea Co Ltd

question 19

Multiple Choice

Kaylea Co. Ltd. has perpetual debt with a face value of $20 million at 5% and a market value of $18 million. It has no preferred shares. Ten million common shares were issued at $12.50 and are now trading for $15.00 each from a high three years ago of $24.00. Common shareholders are demanding a 9% return from companies of equal risk. The company has a tax rate of 35%. It wishes to repurchase four million common shares to reduce the threat of a hostile take-over. Kaylea Co. will use all of its retained earnings of $32 million and fund the balance with perpetual debt at 7% where the market value will equal face value. Assume the cost of Kaylea's old debt will remain unchanged and that share price remains the same. If the repurchase goes through, in absolute terms, what will be the change in the company's cost of capital?

• A) Unchanged
• B) Lower by 1.3%
• C) Lower by 1.1%
• D) Higher by 0.6%
• E) Higher by 0.34%

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Definitions:

Deliberate System

The deliberate system, in psychological theory, refers to one of two systems of thinking: slower, more rational, and conscious thought processes that require effort and deliberation.

Automatic Mind

The aspect of cognitive processing that functions without conscious thought, often responsible for habits, gut reactions, and quick decisions.

Conscious Mind

The aspect of the mind that is aware of one's environment, thoughts, feelings, and experiences at the present moment.

Universal Language

A hypothetical or proposed language that is understood and spoken universally by all human beings.