Heleveton Industries Is 100% Equity Financed

Heleveton Industries is 100% equity financed. Its current beta is 1.1. The expected market risk premium is 8.5%, and the risk-free rate is 4.2%. If Heleveton changes its capital structure to 25% debt, it estimates its beta will increase to 1.2. If the after-tax cost of debt will be 6%, should Heleveton make the capital structure change?

A) Yes, cost of capital decreases by 2.52%
B) Yes, cost of capital decreases 1.67%
C) No, stock price would decrease due to increased risk
D) No, cost of capital increases by 0.85%

Correct Answer:

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