Discount rate or cost of equity: 18% Interest rate or cost of debt: 6.5% Total n

Question

Discount rate or cost of equity: 18%
Interest rate or cost of debt: 6.5%
Total number of shares outstanding: 7,500
Market price (value) per share: $12.95
Book value of equity: $80,000
Book amount/market value of debt: $75,000
Corporate income tax rate: 40%
Personal income tax rate: 35.1%
Sales tax rate: 8.2%
Total revenues: $1,000,000
Net profit (after tax): $25,000
Free Cash Flow: $50,000

a) Using the information above, calculate the weighted average cost of capital (WACC).

b) If this company reduced its debt by 50% from what is shown in the table above, what is the WACC?

c) If this company reduced its debt by 25.0% from what is originally listed in the table above and reduced its cost of equity to 16.0%, what is the WACC?

d) If there is a difference between the WACC you calculated for A and C above, does this indicate a change risk for the company between the two scenarios? Why?

Explanation / Answer

a)E = 7,500*$12.95 =$97125 D= $75,000 V= $75,000 + $97125 = $172,125 Weighted average cost of capital (WACC) =18%*$97125/$172,125 + 60%*6.5%*$75,000/$172,125 = 11.86% b)D= $75,000*50% = $37500 V= $37500+$97125=$134625 Weighted average cost of capital (WACC) =18%*$97125/$134625 + 60%*6.5%*$37500/$134625 = 14.07% c)D= $75,000*75% =$56250 V= $56250+$97125= $153375 Weighted average cost of capital (WACC) =16%*$97125/$153375 + 60%*6.5%*$56250/$153375 = 11.56% d) Yes there is a difference between the WACC calculated for A and C above, and it does indicate a change risk for the company between the two scenarios. Scenario A is more risky

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