Kaylea Co Ltd

Multiple Choice

Kaylea Co. Ltd. has perpetual debt with a face value of $20 million at 5% and a market value of $18 million. It has no preferred shares. Ten million common shares were issued at $12.50 and are now trading for $15.00 each from a high three years ago of $24.00. Common shareholders are demanding a 9% return from companies of equal risk. The company has a tax rate of 35%. It wishes to repurchase four million common shares to reduce the threat of a hostile take-over. Kaylea Co. will use all of its retained earnings of $32 million and fund the balance with perpetual debt at 7% where the market value will equal face value. Assume the cost of Kaylea's old debt will remain unchanged and that share price remains the same. If the repurchase goes through, in absolute terms, what will be the change in the company's cost of capital?

A) Unchanged
B) Lower by 1.3%
C) Lower by 1.1%
D) Higher by 0.6%
E) Higher by 0.34%