Dye Industries Currently Uses No Debt, but Its New CFO

Multiple Choice

Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 40.0% debt (wd) by issuing bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 ? wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity, i.e., what is rL ? rU? $$\begin{array} { l r l r } \text { Risk-free rate, } \mathrm { r } _ { \mathrm { RF } } & 6.00 \% & \text { Tax rate, } \mathrm { T } & 40 \% \\\text { Market risk premium, } \mathrm { RP } _ { \mathrm { M } } & 4.00 \% & \text { Current } \mathrm { w } _ { \mathrm { d } } & 0 \% \\\text { Current beta, } \mathrm { b } _ { \mathrm { U } } & 1.15 & \text { Target } \mathrm { w } _ { \mathrm { d } } & 40 \%\end{array}$$

A) 1.66%
B) 1.84%
C) 2.02%
D) 2.23%
E) 2.45%