Question

The ABC firm is currently unlevered and is valued at \$800,000. Assuming the current of cost...

The ABC firm is currently unlevered and is valued at \$800,000. Assuming the current of cost of equity is 10%. If the firm is issuing \$250,000 in new debt with an 7.6% interest rate. it would repurchase \$250,000 of stock with the proceeds of the debt issue. There are currently 28,000 shares outstanding and its effective marginal tax bracket is 25%. If cost of equity increases to 12.82%, what will ABC’s new WACC be after debt issue?

Value of levered firm = Value of unlevered firm + debt*tax rate

=800000+250000*0.25=862500

D/E = debt/(Value of levered firm-debt)

=250000/(862500-250000)=0.4081

 D/A = D/(E+D) D/A = 0.4081/(1+0.4081) =0.2898 Weight of equity = 1-D/A Weight of equity = 1-0.2898 W(E)=0.7102 Weight of debt = D/A Weight of debt = 0.2898 W(D)=0.2898 After tax cost of debt = cost of debt*(1-tax rate) After tax cost of debt = 7.6*(1-0.25) = 5.7 WACC=after tax cost of debt*W(D)+cost of equity*W(E) WACC=5.7*0.2898+12.82*0.7102 WACC =10.76%

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