Omega Corporation has 11.6 million shares outstanding, now trading at $49 per sh

Question

Omega Corporation has 11.6 million shares outstanding, now trading at $49 per share. The firm has estimated the expected rate of return to shareholders at about 11%. It has also issued long-term bonds at an interest rate of 8%. It pays tax at a marginal rate of 35%. Assume a $170 million debt issuance.

What is Omegas after-tax WACC? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

How much higher would WACC be if Omega used no debt at all? (Hint: For this problem you can assume that the firms overall beta [?A] is not affected by its capital structure or by the taxes saved because debt interest is tax-deductible.) (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Omega Corporation has 11.6 million shares outstanding, now trading at $49 per share. The firm has estimated the expected rate of return to shareholders at about 11%. It has also issued long-term bonds at an interest rate of 8%. It pays tax at a marginal rate of 35%. Assume a $170 million debt issuance.

Explanation / Answer

a. calculation of WACC: Total Capital:

Equity = 11,600,000 x 49 = $568,400,000

Debt = $170,000,000

Total Capital = $738,400,000, Proportion of Equity = 568,400,000 / 738,400,000 = 76.98% , Proportion of Debt = 170,000,000 / 738,400,000 = 23.02%

Cost of Equity = 11%, Cost of Debt = 8%, After Tax Cost of debt = 8 x (1-0.35) = 5.20%

WACC = (Proportion of Equity x Cost of Equity) + (Proportion of Debt x Cost of Debt)

WACC = (76.98 x 0.11) + (23.02 x 0.052)

WACC = 9.66%

b. WACC = 11%

Because now the Firm has only Equity, So Cost of Equity would be the WACC.

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