he Nantucket Nugget is unlevered and is valued at $720,000. Nantucket is current
ID: 2635076 • Letter: H
Question
he 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 of 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 34%.
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 Cost of Bond=8*(1-Tax Rate)=8*(1-0.34) 5.28 WACC=((420000*20.56+300000*5.28)/(420000+300000)) 14.19
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