Omega Corporation has 11.6 million shares outstanding, now trading at $49 per sh

Question

Omega Corporation has 11.6 million shares outstanding, now trading at $49 per share. The firm has estimated the expected rate of return to shareholders at about 11%. It has also issued long-term bonds at an interest rate of 8%. It pays tax at a marginal rate of 35%. Assume a $170 million debt issuance.

What is Omega

Omega Corporation has 11.6 million shares outstanding, now trading at $49 per share. The firm has estimated the expected rate of return to shareholders at about 11%. It has also issued long-term bonds at an interest rate of 8%. It pays tax at a marginal rate of 35%. Assume a $170 million debt issuance.

Explanation / Answer

a) Total Capital raised = 181600000

Capital raised through Equity = 11600000

Capital raised through Bonds = 170000000

Cost of capital for Equity = 0.11

Cost of capital for Bonds= Interest rate (1- Tax rate)

= 8%*(1- 0.35)

= 5.2% = 0.052

Proportion of Equity in Capital = 0.06

Proportion of Debt in Capital = 0.93

Omega after tax Weighted Average Cost of Capital (WACC) = 0.06* 0.11 + 0.93* 0.052

=0.0066 + 0.04836

= 0.054 or 5.5%

b) In case of non issuance of debt, the WACC would be 11% as the entire proportion of capital would be through equity and as it is already mentioned in the question, that 11% is the expected rate of return to the shareholders, hence, WACC would be 11%.

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