Question: BBJ has a debt-equity ratio of 0.2. Current stock price is $50 per share, with 2.5 billion shares outstanding. The firm has a equity beta of 0.5 and can borrow at 4.2%, where the risk free rate is 4%. Market expected return is 10% and their tax rate is 35%.
1. This year expected cash flows are $6.0 billion dollars, in this case what growth rate of free cash flows is consistent with its current share price?
2. BBJ thinks it can add debt without impacting a risk of distress or other costs. With a higher debt to equity ratio of 0.5, borrowing costs will rise to 4.5%. If BBJ announces that it will raise its debt-equity ratio to 0.5, through a leveraged recap (buying back shares) solve for the affect this will have on their stock price.