Question

Bruce & Co. expects its EBIT to be $165,000 every year forever. The company currently has no debt but can borrow at 8.6 percent while its cost of equity is 14.7 percent. The tax rate is 21 percent. The company is planning to borrow $55,000 and use the loan proceeds to repurchase shares. What will be the WACC after recapitalization? Multiple Choice 15.07 percent 14.11 percent 14.51 percent 14.58 percent 14.57 percent

Answer 1

Answer:

14.33%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

According to WACC formula

WACC = ( Cost of equity x Weightage of equity ) + ( Cost of debt ( 1- t) x Weightage of debt )

First Calculate the Weightage

Market Value of Shares = EBIT / cost of equity = $165,000 / 14.7% = $1,122,449

Value of Debt = $55,000

Total = $1,122,449 + $55,000 = $1,177,449

Weightage

Equity =  $1,122,449 / $1,177,449 = 0.9533

Debt = 0.0467

Placing values in the WACC formula

WACC = ( 14.7% x 0.9533 ) + ( 8.6% ( 1 - 0.21 ) x 0.0467 )

WACC = 14.01% + 0.32% = 14.33%