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Question 2 (12 marks) Grand Compassion Ltd. (GCP) is an all equity firm. It has 5,000 shares outstanding with a
current market price of $2.80 per share. The required return on its assets is 10.0% p.a. It
expects to earn $1,400 by the end of the year. The company tax rate is assumed to be 0%. (a) What is the required rate of return on GCP’s equity? How much is the company’s
expected earnings per share (EPS)? (2 marks) (b) GCP’s manager is considering to lever the company up by replacing 40% of its equity
capital with long-term debt at a cost of 7% pa Show the effect of this proposed
capital restructure on GCP’s share price, required return on equity, and expected EPS.
(3 marks) (c) Assuming the return on GCP’s assets and its expected earnings remain at 10.0% and
$1,400 respectively, recalculate the all the results in parts (a) and (b) when a company
tax rate of 33% is effective immediately? (7 marks) m The share price needs to be recalculated when tax is introduced.
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