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Homework answers / question archive / A company has an EBIT of $3211 in perpetuity
A company has an EBIT of $3211 in perpetuity. The unlevered cost of capital is 13.10% and there are 16742 common shares outstanding. The company is considering issuing $6840 in new bonds at par to add financial leverage. The proceeds of the debt issue will be used to repurchase equity. The YTM of the new debt is 8.30% and the tax rate is 21%. What is the WACC after the restructuring?
a. 12.81%
b. 12.50%
c. 12.20%
d. 13.41%
e. 13.11%
Computation of the WACC after the restructuring:-
Value of unlevered firm = EBIT * (1 - tax rate) / Unlevered cost of capital
= $3,211*(1-21%) / 13.10%
= $19,364.05
Value of firm = Value of unlevered firm + (Debt * Tax rate)
= $19,364.50 + ($6,840 * 21%)
= $19,364.50 + $1,436.40
= $20,800.45
Value of equity = Value of firm - Value of debt
= $20,800.45 - $6,840
= $13,960.45
Debt-to-equity ratio = Debt / Equity
= $6,840 / $13,960.45
= 0.49
Weight of debt = $$6,840 / $20,800.45
= 32.88%
Weight of equity = $13,960.45 / $20,800.45
= 67.12%
Levered cost of equity = Unlevered cost of capital + ((Unlevered cost of capital - cost of debt) * (D/E ratio) * (1 - Tax rate))
= 13.10% + ((13.10% - 8.30%) * 0.49 * (1 - 21%))
= 13.10% + 1.86%
= 14.96%
WACC = (Weight of debt * After tax cost of debt) + (Weight of equity * Cost of equity)
= (32.88% * 8.30% * (1 - 21%)) + (67.12% * 14.96%)
= 2.16% + 10.04%
= 12.20%
Correct option is c). 12.20%
