O’Connell & Co. expects its EBIT to be $91,000 every year forever. The firm can

Question

O’Connell & Co. expects its EBIT to be $91,000 every year forever. The firm can borrow at 4 percent. O’Connell currently has no debt, and its cost of equity is 9 percent and the tax rate is 35 percent. The company borrows $136,000 and uses the proceeds to repurchase shares.

What is the cost of equity after recapitalization?

What is the WACC? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

I tried calculating and got 10.70% for equity and 9.00% for WACC, which I know is incorrect.

Explanation / Answer

Valuation of the firm = EBIT * (1 - tax rate) / Cost of equity

= $91,000 * (1 - 35%) / 9%

= $657,222 which is the equity value since there is no debt

After recapitalization, Equity = $657,222 - $136,000

= $521,222

Cost of equity after recapitalization = (EBIT - Interest cost) * (1 - tax rate) / Equity * 100%

= ($91,000 - 4% * 136,000) * (1 - 35%) / $521,222 * 100%

= 10.67%

WACC = Cost of equity * Weightage of equity + Cost of debt * Weightage of debt * (1 - tax rate)

= 10.67% * ($521,222 / $657,222) + 4% * ($136,000 / $657,222) * (1 - 35%)

= 9.00%

I have also got the same answer. Are you sure the answer is wrong?

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