Here is Establishment Industries’ market-value balance sheet (Figures in million

Question

Here is Establishment Industries’ market-value balance sheet (Figures in millions): Net working capital $ 700 Debt $ 1,050 Long-term assets 2,500 Equity 2,150 Value of firm $ 3,200 $ 3,200 Here is Establishment Industries’ market-value balance sheet (Figures in millions): Net working capital $ 700 Debt $ 1,050 Long-term assets 2,500 Equity 2,150 Value of firm $ 3,200 The debt is yielding 6.5%, and the cost of equity is 14.5%. The tax rate is 31%. Investors expect this level of debt to be permanent. What is Establishment’s WACC? How would the market-value balance sheet change if Establishment retired all its debt? Net working capital $ Debt $ Long-term assets $ Equity $ Value of firm $ Total $

Explanation / Answer

1.) Calculation of WACC Nature of Fund Amount Cost of Capital Weight Weighted Cost of Capital Debt 1050 4.49% 0.33 1.47% Equity 2150 14.5% 0.67 9.74% Total 3200 WACC 11.21% Note 1: Cost of debt(kd) = Interest Rate (1-Tax Rate) 2.) Item Old Value of Balance Sheet Change New Values Debt 1050 -1050 0 Equity 2150 0 2150 Long Term Asset 2500 0 2500 Net Working Capital 700 -1050 -350

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