Question

The simplified balance sheet for the Dutch manufacturer Rensselaer Felt (figures in € thousands) is as follows:

Cash and marketable securities	€	2,300		Short-term debt	€	76,400
Accounts receivable		120,800		Accounts payable		62,800
Inventory		125,800		Current liabilities	€	139,200
Current assets	€	248,900
Property, plant, and equipment		212,800		Long-term debt		209,400
Deferred taxes		45,800
Other assets		88,200		Shareholders' equity		247,100
Total	€	595,700		Total	€	595,700

The debt has an interest rate of 4.00% (short term) and 6.00% (long term). The expected rate of return on the company's shares is 13.00%. There are 7.54 million shares outstanding, and the shares are trading at €54. The tax rate is 25%. Assume the company issues €50 million in new equity and uses the proceeds to retire long-term debt. Also assume the company's borrowing rates are unchanged and the short-term debt is permanent. Use the three-step procedure.

a. Calculate the cost of equity after the capital restructuring. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Long-term debt	€ 209,400	33.96%	6.00%
Equity	€ 407160	66.04%	13.00%
	616,560	100%

Re before Restructuring	Re = (Rd*Wd) + (Re*We)
	= ((0.3396*0.06) + (0.6604*0.13)
	= 10.62%

Long-term debt	€ 159,400	25.85%	6.00%
Equity	€ 457160	74.15%	13.00%
	616,560	100%

Re after Restructuring	Re = R + (R - Rd) * (D/E)
	= 10.62 + (10.62 - 6) * (159,400 / 457,160)
	= 12.23%

.

Short-term debt	€ 76,400	11.03%	4.00%
Long-term debt	€ 159,400	23.00%	6.00%
Equity (7.57 million x $45)	€ 457,160	65.97%	13.00%
	€ 692,960	100%

WACC after Capital Restructuing

= 0.04 (1 - 0.25) (0.1103) + 0.06 (1 - 0.25) (0.23) + 0.1223 (0.6597) = 0.003309 + 0.01035 + 0.08068131 = 0.09434

WACC = 9.43%