Question

Samsung currently has 5 million shares outstanding, trading at $24.97 and no debt. The stock's beta is 1.2. T-Bills currently yield 0.5% and the expected return on the S&P 500 is 5%.

The company is thinking of issuing 81 million of debt to repurchase its own stock. The yield to maturity on similar bonds issued by other companies is 5%. The average tax rate is 34%. Use CAPM

What is the company's current WACC? Based on what happens to the value of the company after the restructuring, what must be the new market value of its equity (in $ million)?

What is the new rate of return equity?

What is the new WACC?

Answer #1

Current WACC = Current required rate of equity

Using CAPM, Required rate, r = Rf + beta x (Rm - Rf) = 0.5% + 1.2 x (5% - 0.5%) = 5.9%

Current Value of equity = 5m x 24.97 = 124.85m

After debt, new value of firm = Unlevered value + Tax rate x Debt

= 124.85 + 34% x 81 = 152.39

Debt = 81m => New equity = 71.39 million

Levered beta = Unlevered beta x (1 + (1 - tax) x D/E) = 1.2 x (1 + (1 - 34%) x 81 / 71.39) = 2.10

New Required rate of equity, re = 0.5% + 2.10 x (5% - 0.5%) = 9.94%

New WACC = wd x rd x (1 - tax) + we x re

= (81 / 152.39) x 5% (1 - 34%) + (71.39 / 152.39) x 9.94%

= 6.41%

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