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(5 points) In t=0, Sanoti Ltd. is an unlevered company whose Beta is 2. The market return is 6%. The risk-free rate is 4%. To begin with, assume that capital markets are perfect and Modigliani-Miller assumptions hold true. (a) Determine the required cost of equity using CAPM. (b) Given your answer in part (a), suppose that in t=1 Sanoti does a leveraged recapitalization, issuing risk-free debt and repurchasing stocks until its debt-equity ratio is 0.5. The rate of return on debt is 4% and the corporate tax rate is zero (c=0). i. Will the WACC of GAM change after the recapitalization? Explain why in max 2 lines. ii. What is the cost of equity of the levered firm? Briefly discuss your answer (max 2 lines). (c) In t=2, the government increases the corporate tax rate to 20%. If the debt-equity ratio is still 0.5, compute the (after-tax) WACC. (5 points) In t=0, Sanoti Ltd. is an unlevered company whose Beta is 2. The market return is 6%. The risk-free rate is 4%. To begin with, assume that capital markets are perfect and Modigliani-Miller assumptions hold true. (a) Determine the required cost of equity using CAPM. (b) Given your answer in part (a), suppose that in t=1 Sanoti does a leveraged recapitalization, issuing risk-free debt and repurchasing stocks until its debt-equity ratio is 0.5. The rate of return on debt is 4% and the corporate tax rate is zero (c=0). i. Will the WACC of GAM change after the recapitalization? Explain why in max 2 lines. ii. What is the cost of equity of the levered firm? Briefly discuss your answer (max 2 lines). (c) In t=2, the government increases the corporate tax rate to 20%. If the debt-equity ratio is still 0.5, compute the (after-tax) WACC

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