Blueline Publishers is considering a recapitalization plan.It is currently 100% equity financed but under the plan it would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock.The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, which is currently 15%.The CFO believes that this recapitalization would reduce the WACC and increase stock price.Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?

Question

Quizplus · Accepted Answer

By issuing debt to repurchase equity, the company increases its financial leverage. This increases the risk to equity holders since debt has a fixed claim on the company's income before equity does. As a result, the cost of equity would increase to compensate for the higher risk.

Blueline Publishers Is Considering a Recapitalization Plan