Omega Corp. currently has 200,000 shares of stock outstanding and no debt. Howev
ID: 2650605 • Letter: O
Question
Omega Corp. currently has 200,000 shares of stock outstanding and no debt. However, they are planning on issuing debt in order to buy back stock. Their EBIT is a constant $500,000 regardless of how much debt they issue and they pay all net income out as dividends. Their tax rate is 40%. They have estimated the following costs of debt and costs of equity for various levels of debt.
EBIT =
500,000
Tax Rate
40%
Share
Debt
Rd
Re
Net Inc
Equity Value
Firm Value
% Debt
WACC
Price
0
6.00%
9.00%
300,000
3,333,333
3,333,333
0.00%
9.00%
16.67
500,000
6.30%
9.40%
2,990,426
3,490,426
14.32%
XXXX
1,000,000
6.80%
10.00%
1,500,000
7.50%
11.00%
41.51%
XXXX
18.07
2,000,000
8.50%
12.50%
XXXX
3,584,000
8.37%
2,500,000
10.00%
14.50%
3,000,000
12.00%
17.00%
84,000
XXXX
85.86%
17.47
22. What will their Net Income be if they issue $2,000,000 in debt?
a. $158,000 b. $172,000 c. $198,000 d. $216,000
23. What will their WACC be if they issue $1,500,000 in debt?
a. 8.23% b. 8.30% c. 8.36% d. 8.42%
24. What will their Share Price be if they issue $500,000 in debt?
a. $16.94 b. $17.12 c. $17.45 d. $17.72
25. What is the value of the firm?s equity if they issue $3,000,000 worth of debt?
a. 500,000 b. 1,500,000 c. 2,000,000 d. 2,500,000
EBIT =
500,000
Tax Rate
40%
Share
Debt
Rd
Re
Net Inc
Equity Value
Firm Value
% Debt
WACC
Price
0
6.00%
9.00%
300,000
3,333,333
3,333,333
0.00%
9.00%
16.67
500,000
6.30%
9.40%
2,990,426
3,490,426
14.32%
XXXX
1,000,000
6.80%
10.00%
1,500,000
7.50%
11.00%
41.51%
XXXX
18.07
2,000,000
8.50%
12.50%
XXXX
3,584,000
8.37%
2,500,000
10.00%
14.50%
3,000,000
12.00%
17.00%
84,000
XXXX
85.86%
17.47
Explanation / Answer
22. What will their Net Income be if they issue $2,000,000 in debt?
Net Income = (EBIT - Interest Expense*(1-tax rate)
Net Income = (500000 - 2000000*8.50%)*(1-40%)
Net Income = $ 198000
Answer
c. $198,000
23. What will their WACC be if they issue $1,500,000 in debt?
WACC = Weight of Equity* Cost of Equity + Weight of Debt* After Tax cost of Debt
WACC = (1-41.51%)*11 + 41.51%*7.50*(1-40%)
WACC = 8.30%
Answer
b. 8.30%
24. What will their Share Price be if they issue $500,000 in debt?
Share Price = Firm Value/No of outstanding share
Share Price = 3490620/200000
Share Price = 17.45
Answer
c. $17.45
25. What is the value of the firms equity if they issue $3,000,000 worth of debt?
Frms equity = 3000000/(85.86%) * (1-85.86%)
Frms equity = 494060
Answer
a. 500,000 (approx)
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