Question

ABC Telecom Inc. currently is financed with 10% debt and 90% equity. However, its CFO has proposed that the firm issue new long-term debt and repurchase some of the firm’s common stock. Its advisers believe that the long-term debt would require a before-tax yield of 10%, while the firm’s basic earning power is 14%. The firm’s operating income and total assets will not be affected. The CFO has told the rest of the management team that he believes this move will increase the firm’s stock price. If ABC Telecom Inc. proceeds with the recapitalization, which of the following items are also likely to increase? Check all that apply.

Answer 1

Answer:

The Cost of equity and cost of debt would likely to increase

Explanation:

If the debt rises so the cost of debt is also rising. Moreover, the higher leverage represents more risk in which the cost of equity also increased

In the given situation, both the cost of debt and cost of equity is rises but the net income would be decline because there is high interest expense and at the same time the assets would be remain the same and return on assets would be lesser