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Homework answers / question archive / A company has an EBIT of $3,876 in perpetuity
A company has an EBIT of $3,876 in perpetuity. The unlevered cost of capital is 14.30%, and there are 20,467 common shares outstanding. The company is considering issuing $8,115 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 9.45% and the tax rate is 26%. What is the weighted average cost of capital after the restructuring?
Question 24 options:
11.97%
12.29%
12.62%
12.94%
13.26%
Computation of the weighted average cost of capital after the restructuring:-
Value of unlevered firm = EBIT * (1 - tax rate) / Unlevered cost of capital
= $3,876 * (1 - 26%) / 14.30%
= $2,868.24 / 14.30%
= $20,057.62
Value of firm = Value of unlevered firm + (Debt * Tax rate)
= $20,057.62 + ($8,115 * 26%)
= $20,057.62 + $2,109.90
= $22,167.52
Value of equity = Value of firm - Value of debt
= $22,167.52 - $8,115
= $14,052.52
Debt-to-equity ratio = Debt / Equity
= $8,115 / $14,052.52
= 0.58
Weight of debt = $8,115 / $22,167.52
= 36.61%
Weight of equity = $14,052.52 / $22,167.52
= 63.39%
Levered cost of equity = Unlevered cost of capital + ((Unlevered cost of capital - cost of debt) * (D/E ratio) * (1 - Tax rate))
= 14.30% + ((14.30% - 9.45%) * 0.58 * (1 - 26%))
= 14.30% + (4.85% * 0.58 * 74%)
= 14.30% + 2.07%
= 16.37%
WACC = (Weight of debt * After tax cost of debt) + (Weight of equity * Cost of equity)
= (36.61% * 9.45% * (1 - 26%)) + (63.39% * 16.37%)
= 2.56% + 10.38%
= 12.94%
Correct option is 4). 12.94%
