Question

Experian Company has expected earnings of $1,180,000 and a market value of equity of $12,400,000. The firm is planning to issue $4,700,000 of debt at 6.7 percent interest and use the proceeds to repurchase shares at their current market value. Ignore taxes. What will be the cost of equity after the repurchase?

		11.66%
		11.45%
		11.36%
		11.24%
		10.96%

Answer 1

ACC will be same even after debt is introduced as per M&M theorem;

initial cost of equity ke=earnings/Market value of equity=1180000/12400000 =9.51%

cost of debt= kd=6.7%

wacc= (E/V)*ke +(D/V)*kd

where E=market value of equity ;D=debt ;V=firm value=E+D=12400000+4,700,000 =17100000

old wacc=9.51% --- no debt initially hence D=0

let ke1 =new equity

Market value of equity after repurchase=12400000-4,700,000=7700000

V=12400000

wacc= (7700000/12400000)*ke1 +(4,700,000/12400000)*6.7 =9.51%

ke1=11.24% --cost of new equity