Salish Industries is an all-equity firm whose stock has a beta of 1.2 and an expected return of 12.5%. Suppose it issues new risk-free debt with a 5% yield and repurchases 40% of its stock. Assume perfect capital markets.
a.What is the beta of Salish stock after this transaction?
b.What is the expected return of Salish stock after this transaction?
Suppose that prior to this transaction, Salish had expected EPS this coming year of $1.50, with a forward P/E ratio (that is, the share price divided by the expected earnings for the coming year) of 14.
c.What is Salish’s expected EPS after this transaction? Does this change benefit shareholders? Explain.
d.What is Salish’s forward P/E ratio after this transaction? Is this change in the P/E ratio reasonable? Explain.