Omega Corporation has 11.0 million shares outstanding, now trading at $65 per sh

ID: 2765135 • Letter: O

Question

Omega Corporation has 11.0 million shares outstanding, now trading at $65 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 7%. It pays tax at a marginal rate of 40%. Assume a $250 million debt issuance.

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

b. How much higher would WACC be if Omega used no debt at all? (Hint: For this problem you can assume that the firm’s 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.) WACC %

Explanation / Answer

Calculation of WACC

Particulars

Market value

Weight as per Market value

Cost of capital

WACC

Equity (11*65)

715

0.740932642

8.15

Debt

250

0.259067358

(7*0.60) 4.2

1.09

Total

965

9.24

b) WACC without Debt = 11*100%

= 11

If Omega used no debt at all,WACC would be higher by 1.76% (11-9.24).