Question

Trump Limited operates out of Miami Florida USA. Trump’s current earnings before interest and tax are $950,000. He projects that there will be no growth in earnings for the foreseeable   future. Trump currently has no debt, but if he choose to borrow his cost of borrowing is   seven percent. His unlevered cost is 11 percent, while his tax rate is 20 percent.

Trump is seeking to add leverage to his company and consequently borrowed $350,000 from Biden Banking Group.

What will be Trump’s WACC be after recapitalization? Kindly show all workings.

Answer 1

value of the firm = $950000*(1-20%)/11% = $6,909,091

so according to MM's Theory company's before tax cost of capital will remain the same whether it is leveraged or unleverd.

WACC (Before Tax ) = ((350000*7%)+(6559091*???))/6909091

11%*6909091 = 24500 + (6559091*???)

760000 = 24500 + (6559091*???)

735500 = 6559091*???

??? = 11.21%

before tax cost of After Tax Cost of debt = 7%*(1-20%) = 5.6%

WACC after Tax(for the leavered firm = ((350000*5.6%)+(6559091*11.21%))/6909091 = 10.93%