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21，A company has an EBIT of $4,750 in perpetuity. The unlevered cost of capital is 16.46%,...

21，A company has an EBIT of $4,750 in perpetuity. The unlevered cost of capital is 16.46%, and there are 27,230 common shares outstanding. The company is considering issuing $10,410 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 11.52% and the tax rate is 35%. What is the weighted average cost of capital after the restructuring?
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Answer #1

Currently

EBIT = $4750

Less I = 0

Less Tax @ 35% = $1662.50

PAT =$3087.50

So, value of equity= value of company = $3087.50/0.1646 = $18757.59

After stock repurchase,

Value of Levered firm =Value of unlevered firm + Debt * tax rate = $18757.59 + $10410*0.35 =$22401.09

Value of Debt = $10410

Value of Equity =$22401.09-$10410= $11991.09

new Cost of levered equity = 16.46%+ (16.46%-11.52%)*10410/11991.09*(1-0.35) = 0.19248 =19.248%

So, WACC = 10410/22401.09*11.52%*(1-0.35)+ 11991.09/22401.09 * 19.248%

= 0.13783 or 13.78%

Alternatively,

Value of Levered firm =Value of unlevered firm + Debt * tax rate = $18757.59 + $10410*0.35 =$22401.09

NOPAT = EBIT*(1-tax rate) = $4750 *0.65 =$3087.50

So, WACC = NOPAT/Value of firm =3087.50/22401.09 = 0.1378 or 13.78%

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