Bruce & Co. expects its EBIT to be $74,000 every ye company cuirrently has no de

Question

Bruce & Co. expects its EBIT to be $74,000 every ye company cuirrently has no debt, its cost of equity is 12 percent, and the tax rate is 35 percent. The company ar forever. The company can borrow at 7 percent. The borrows $125,000 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.) Cost of equity What is the company's WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Solution:

a. VU = $74,000(1 - 0.35)/0.12 = $400,833.33
VL = $400,833.33 + 0.35($125,000) = $444,583.33

VE = $444,583.33 - $125,000 = $319,583.33
RE = 0.12 + (0.12 - 0.07)($125,000/$319,583.33)(1 - 0.35) = 0.1327

RE = 13.27%
b. WACC = 0.1327*$319,583.33/$444,583.33 + 0.07($125,000/$444,583.33) (1 - 0.35)

WACC = 10.82 percent

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