Your firm is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 9% and use the proceeds to repurchase some of its common stock. The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, 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.

Question

Quizplus · Accepted Answer

Issuing debt increases financial risk, which typically leads to an increase in the cost of equity.

Your Firm Is Currently 100% Equity Financed