Question

**PLEASE ANSWER B**

Omega Corporation has 11.7 million shares outstanding, now trading at $48 per share. The firm has estimated the expected rate of return to shareholders at about 10%. It has also issued long-term bonds at an interest rate of 9% and has a debt value of $165 million. It pays tax at a marginal rate of 21%.

a. What is Omega’s after-tax WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
9.34%

b. What would WACC be if Omega used no debt at all? (Hint: For this problem, you can assume that the firm’s overall beta [β_A] is not affected by its capital structure or by the taxes saved because debt interest is tax-deductible.) (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

a.Market value of equity = 11.7 million*$48 = $561.60 million

Value of the firm = $561.60 million + $165 million = $726.60 million

Weight of debt = $165 million / $726.60 million

= 0.2271

Weight of equity = $561.60 million / $726.60 million

= 0.7729

After -tax WACC is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

Where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

WACC = 0.2271*9%*(1 - 0.21) + 0.7729*10%

= 0.2271*7.11% + 0.7729*10%

= 1.6147% + 7.7290%

= 9.3437% 9.34%.

b.Omega's WACC with no debt is calculated by using the formula below:

WACC= wd*kd + we*ke

Where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

WACC = 0.2271*9%+ 0.7729*10%

= 2.0439% + 7.7290%

= 9.7729% 9.77%.