Abbee Aviation (AV) has 40 million shares of stock outstanding, that trade at $40. The risk-free interest rate is 2% and the market risk premium is 8.9%. This stock has a beta of 2.7. AV also has $400 million in 9% bonds outstanding and the company has a 42% tax rate. Show all calculations for each of your answers to earn full credit.
Part 1: a) Calculate the firm's market capitalization and then calculate the enterprise value.
b) Use the CAPM formula to determine the firm's cost of equity, and
c) Utilize this information to calculate AV's weighted average cost of capital.
Part 2: a) Assume that Abbee Aviation issues $200 million in bonds to buy back $200 million in common stock in order to recapitalize the firm. What is AV's new WACC?
b) Finally, discuss why there is a change in WACC and explain the impact of the components of capital structure on a company's cost of capital.