Omega Corporation has 10.6 million shares outstanding, now trading at $61 per sh

Question

Omega Corporation has 10.6 million shares outstanding, now trading at $61 per share. The firm has estimated the expected rate of return to shareholders at about 12%. It has also issued long-term bonds at an interest rate of 8%. It pays tax at a marginal rate of 40%. Assume a $230 million debt issuance.

What is Omega

Omega Corporation has 10.6 million shares outstanding, now trading at $61 per share. The firm has estimated the expected rate of return to shareholders at about 12%. It has also issued long-term bonds at an interest rate of 8%. It pays tax at a marginal rate of 40%. Assume a $230 million debt issuance.

Explanation / Answer

Market value of equity (E)=10.6*61=$646.6mn

Market value of debt (D)=$230 million

A . After tax WACC=cost of equity*(E/(D+E))+cost of debt*(1-T)**(D/(D+E))

After tax WACC= 0.12*(646.6/(646.6+230))+0.08*(1-0.4)*(230/(646.6+230))= 10.111%

b. In case of no debt D/(D+E) =0

WACC=cost of equity =12%

WACC will be higher by 1.889%(12%-10.111%)

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