Bruce & Co. expects its EBIT to be $98,000 every year forever. The company can b
ID: 2761398 • Letter: B
Question
Bruce & Co. expects its EBIT to be $98,000 every year forever. The company can borrow at 6 percent. The company currently has no debt, its cost of equity is 12 percent, and the tax rate is 35 percent. The company borrows $140,000 and uses the proceeds to repurchase shares.
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 company's WACC?
Bruce & Co. expects its EBIT to be $98,000 every year forever. The company can borrow at 6 percent. The company currently has no debt, its cost of equity is 12 percent, and the tax rate is 35 percent. The company borrows $140,000 and uses the proceeds to repurchase shares.
Explanation / Answer
Answer
Answer (a)
What is the cost of equity after recapitalization?
Figures in $
Particulars
Amount
EBIT
a
98000
Interest (as no debt)
b
0
EBT (a-b)
c
98000
Tax rate (35%)
d
34300
EAT (c-d)
e
63700
Cost of Equity
f
12.00%
Market value of Equity (e/f)
530833.33
Figures in $
Particulars
Amount
EBIT
a
98000
Interest
b
8400
(140000*0.06)
EBT (a-b)
c
89600
Tax Rate (35%)
d
31360
EAT (c-d)
e
58240
New Market value of Equity
f
390833.33
(530833.33-140000)
Cost of Equity (e/f)
14.90%
Answer : The cost of equity after recapitalization is 14.90%
Answer (b)
What is the company's WACC?
Particulars
Market value
Weight
Cost of Capital
Weighted average cost of capital
A
B
A*B
New value of Equity
390833.33
0.736
14.90%
10.97%
Debt
140000
0.264
3.90%
1.03%
0.06*(1-0.35)
530833.33
1
Weighted Average Cost of Capital
12.00%
Answer : Company’s WACC is 12.00%
Figures in $
Particulars
Amount
EBIT
a
98000
Interest (as no debt)
b
0
EBT (a-b)
c
98000
Tax rate (35%)
d
34300
EAT (c-d)
e
63700
Cost of Equity
f
12.00%
Market value of Equity (e/f)
530833.33
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