Cyberdyne Systems is a military/defense products company.Cyberdyne Systems is all equity financed.Cyberdyne has 200 million shares outstanding which trade for $20 per share.Cyberdyne's shareholders require a return of 10%.
Omni Defense Products Inc.is also a military/defense products company.It's shares are trading for $35 per share.Omni has 100 million shares outstanding.Omni has debt worth $3 billion.Omni's debt is priced to yield 6.5%.
What is the required return of Omni's shareholders? (Assume that the tax rate is 0%.)

Question

Quizplus · Accepted Answer

The required return of shareholders in the levered firm is given by M&M Proposition II: k_E = k_U + (k_U - k_D) 11ea7fdb_fc61_bb22_a768_19df676a5ab0_TB2902_11 Cyberdyne is all equity financed, so k_U is equal to the return required by its shareholders: k_U = 10% For Omni: E = $35 × 100 M = $3,500M D = $3,000M 11ea7fdb_fc61_bb23_a768_59d675bead2e_TB2902_11 = 11ea7fdb_fc61_bb24_a768_f16580002b88_TB2902_11 = 0.8571 k_E = 0.10 + (0.10 - 0.065) × 0.8571= 0.13 or 13%

Cyberdyne Systems Is a Military/defense Products Company