Gator Fabrics Inc. currently has zero debt. It is a zero growth company, and it
ID: 2679177 • Letter: G
Question
Gator Fabrics Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACC - WACC?New Debt/Assets
35%
Orig cost of equity, rs
10.0%
New Equity/Assets
65%
New cost of equity = rs
11.0%
Interest rate new = rd
7.0%
Tax rate
40%
Explanation / Answer
Cost of Equity * percent that is equity + Cost of Debt * percent that is debt * (1-tax rate) so old: All equity = 100%*.1=.1 new: .65*.11+.35*.07*.6=.0862 subtract them which way you need. Not sure which way to do but it is .0138 or - the same.
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