Question

ABC Company has an opportunity to float a bond issue for $10,750,000 issued at par with a 5.3% coupon payment. They will use the funds to pay off the bank debt and provide some working capital for a new project. The exchange of debt is expected to reduce the beta on the stock to 1.22. 1. What is the new cost of debt after the exchange of bonds for bank debt? 2. What is the new cost of equity after some debt related risk adjustment? 3. What is the new WACC after changes to the debt structure?

Answer 1

1. Cost of debt (kd) = Pre-tax cost of debt * (1- Tax rate) . Here the tax rate isn't mentioned, so assume no tax.

Therefore, new cost of debt = 5.3%

2. Since the beta value has reduced, so will the cost of equity.

Cost of equity(ke) = Risk-free rate + Beta (Market Rate of Return - Risk-Free Rate)

More information is required here.

3. WACC= (E/V)* ke + kd*(D/V)

E= Equity Value (Not GIven), D= Debt Value= $10,750,000, V=E+D

Not all information is given here. You will just have to plug in the values for the final answer