LVMH currently has a debt-to-capital ratio of 10% and an average tax rate of 34%
ID: 2750854 • Letter: L
Question
LVMH currently has a debt-to-capital ratio of 10% and an average tax rate of 34%. LVMH's bonds have a 4% yield to maturity. Using the CAPM, the firm estimates that its cost of equity is 12%.
The firm is considering a new capital structure with a debt-to-capital ratio of 50%. An investment bank has estimated that the yield to maturity on the company's bonds would rise to 8%.
The risk-free rate is 2% and the expected equity market risk premium is 7%.
1. What would be the new beta if the company goes ahead with the recapitalization?
2. What would be the new cost of equity after the recapitalization?
3. What would be the new WACC after the recapitalization?
Explanation / Answer
New Beta of the Company Beta Asset= Assuming it to be a constant 1 Beta Equity= Beta Asset[1+(1-t)D/E] 1*[1(1-0.34).5] 0.83 Cost of Equity= risk Free Return+Beta(Market Permium) 0.02+.83(.07) 0.02 0.0581 Cost of Equity= risk Free Return+Beta(Market Permium) 0.0781 New WACC=Debt/Debt+Equity(kd(1-taxrate)+Equity/Debt+Equity(Cost of Debt) 0.5[0.08(1-.34)]+0.5(.0781) 0.5*.0528+05*.0781 0.03905
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