Question

Company A currently has market capitalization (value of its equity) of $9,062.49 million, a debt-equity ratio of .1822, and a WACC of 4.65%. The government of the country in which Company A operates, Utopia, has no corporate taxes (T=0). The Firm has decided it’s a good time to restructure its capital. It will buy back some of its debt and issue new equity to achieve the industry-average debt-equity ratio of 0.54. What will the Company’s weighted average cost of capital be post-restructuring?

Please explain step by steps. Thank you!

Answer #1

In case of absence of taxes WACC should remain same when debt
restructuring is done

WACC = Weight of Debt * Cost of Debt + Weight of equity * Cost of
equity

As debt increases cost of equity increases because of the
formula

Cost of Levered Equity = Cost of Unlevered Equity* Debt/Equity*(
Cost of Unlvered Equity - Cost of Debt)

From this equation it is clear that higher the DEBT/Equity ratio
higher is the cost of equity.

When debt equity ratio increases from 0.1822 to 0.54 cost of equity
increases but Cost of Debt remains same.

Hence WACC remains same since lack of taxes makes interest non tax
deductible.

Please Discuss in case of Doubt

Best of Luck. God Bless

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