1 answer

Yerba Industries is an all-equity firm whose stock has a beta of 0.60 and an expected return of 20%. Suppose

Question:

Yerba Industries is an all-equity firm whose stock has a beta of

and an expected return of . Suppose it issues new risk-free debt with a

yield and repurchase of its stock. Assume perfect capital markets.

a. What is the beta of Yerba stock after this transaction?

b. What is the expected return of Yerba stock after this transaction?

Suppose that prior to this transaction, Yerba expected earnings per share this coming year of ,

with a forward P/E ratio (that is, the share price divided by the expected earnings for the coming year) of .

c. What is Yerba's expected earnings per share after this transaction? Does this change benefit the shareholder? Explain.

d. What is Yerba's forward P/E ratio after this transaction? Is this change in the P/E ratio reasonable? Explain.


Answers

C) Does this change benefit the shareholder? Explain.

Answer: It does not benefit shareholders because the risk of holding equity has increased.


D) Is this change in the P/E ratio reasonable? Explain.

Answer: It is reasonable. P/E has gone down because risk has gone up


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