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Meyer & Co. Expects its EBIT to be $97,000 every year forever. The firm can borrow at 8 percent. The company currently has no debt, and its cost of equity is 13 percent and the tax rate is 24 percent. The company borrows $195,000 and uses the proceeds to repurchase shares. a. What is the cost of equity after recapitalization? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.G., 32.16.) b. What is the WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.G., 32.16.)

Respuesta :

jepessoa

Answer:

a) 14.77%

b) 12%

Explanation:

first we must determine the price of the company when it has no debt (unlevered) = [$97,000 x (1 - 24%)] / 13% = $567,076.92

the value of the firm after it has taken the debt = $567,076.92 + ($195,000 x 24%) = $613,876.92

debt to equity ratio(D/E) = $195,000 / ($613,876.92 - $195,000) = 0.4655

new cost of equity (Re) = old cost of equity + [(old cost of equity - cost of debt) x D/E ratio x (1 - tax rate)] = 13% + [(13% - 8%) x 0.4655 x 0.76] = 14.77%

WACC = (0.6823 x 14.77%) + (0.3177 x 8% x 0.76) = 10.08% + 1.92 = 12%

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