Leisure Inc. has the following information concerning its debt and equity:
The firm has 2M common shares outstanding. They were issued at a price of $20
and are currently trading at a price of $35. The shares yesterday paid a dividend
of $2.38 and the dividend is expected to grow by 5% per year, forever.
The firm also has 15,000 zero coupon bonds outstanding. The bonds have four
years to maturity and are trading at $850 each. The par value of each bond is
$1,000. The firm has a marginal tax rate of 25%.
a. What is the required rate of return on the firm’s common shares?
b. What is the required rate of return on the firm’s debt?
c. What is the required rate of return on the firm’s assets?
d. Assuming that the cost of equity and debt remain the same, what will happen to the firm’s required return on assets if they issue $10M in new debt and use it to
repurchase common stock?
e. The cost of debt can increase or decrease as a firm takes on additional debt. Discuss