Question

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?

Answer 1

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%