Question

6，A
company has an EBIT of $4,865 in perpetuity. The unlevered cost of
capital is 16.70%, and there are 27,970 common shares outstanding.
The company is considering issuing $10,660 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 11.75% and the tax
rate is 36%. What is the cost of the levered equity after the
restructuring?

Answer #1

WACC after restructuring | |||||||

Value of Unlevered firm = | |||||||

EBIT*(1-Tax)/Re(levered) | |||||||

EBIT = | 4865 | ||||||

Tax rate = | 36% | ||||||

Re (unlevered) | 16.70% | ||||||

Value of UnLevered firm = | 18644.31 | ||||||

Value of levered firm = | 22481.91 | ||||||

18644.31+10660*36% | |||||||

Debt to borrow = | 10660 | ||||||

YTM on debt = | 11.75% | ||||||

RE (Levered)= | 16.7%+(16.7%-11.76%)*(10660/(22481.91-10660)*(1-36%) | ||||||

19.56% | |||||||

Answer = |
19.56% |

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