The Nantucket Nugget is unlevered and is valued at $720,000. Nantucket is curren
ID: 2635075 • Letter: T
Question
The Nantucket Nugget is unlevered and is valued at $720,000. Nantucket is currently deciding whether including debt in its capital structure would increase its value. The current cost of equity is 12%. Under consideration is issuing $300,000 in new debt with an 8% interest rate. Nantucket would repurchase $300,000 of stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero.
What is Nantucket's new cost of equity?
What is Nantucket's new weighted average cost of capital (WACC)?
Explanation / Answer
Value of Shares 720000 Price of each Share=720000/32000 22.5 Introduction of debt 300000 Cost of Equity=12% , So Dividend=Cost of equity*Price of the Share=0.12*22.5 2.7 After purchase of stockstock value=720000-300000 420000 Price of each Share=420000/32000 13.125 Cost of Equity=Dividend/Price=(2.7/13.135)*100 20.56 WACC=((420000*20.56+300000*8)/(420000+300000)) 15.33
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