Buckeye Corp. is currently an all equity firm with a market value of equity of $

Question

Buckeye Corp. is currently an all equity firm with a market value of equity of $100 million. The current expected return on Buckeyes equity is 25%. Buckeye operates in a world with no taxes. Buckeye is planning on issuing $10 million in debt with an interest rate of 10% and using the cash to repurchase $10 million in shares. There are no corporte or personal taxes.

a). After Buckeye repurchases the stock, what will the expected return on the firms stock?

b). After Buckeye repurchases the stock, what will be the firm's weighted average cost of capital?

Explanation / Answer

a). After Buckeye repurchases the stock, what will the expected return on the firms stock?

($100 mil)(25%) = 25 million

After purchasing 10 millinon the expected return will become:

($25 million / $90 Million) x 100 = 27.78%

b). After Buckeye repurchases the stock, what will be the firm's weighted average cost of capital?

WACC = (90 mil / 100 mil) x .2778 + (10 mil / 100 mil) x .10

WACC = 26%

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