iii) What is the firm\'s WACC after restructuring? iv) How many shares remain af
ID: 2805106 • Letter: I
Question
iii) What is the firm's WACC after restructuring? iv) How many shares remain after recapitalization? v) What is the firm's corporate value after restructuring 4. Two otherwise identical companies differ only with respect to their capital structure. Gizmo Inc is unlevered while Acme Inc. has S1 million of 7% bonds outstanding. The corporate tax rate is 34%. EBIT is $3 million and the ruis 10%. Assume all MM assumptions are satisfied. i. What is the value of each firm? ii. What is r, for Acme? iii. Wh at is St for Acme? iv. What is the WACC for Acme?Explanation / Answer
i) Current Equity = 0.5 x 30 = 15m, Debt = 15m => D/E = 1
Using CAPM, Required Return = Rf + beta x MRP
=> 12% = 4% + beta x 5% => Levered beta = 8/5 = 1.6
Unlevered beta = Levered beta / (1 + (1 - tax) x D/E) = 1.6 / (1 + (1 - 20%) x 1) = 0.89
ii) New levered beta = Unlevered beta x (1 + (1 - tax) x D/E) = 0.89 x (1 + (1 - 20%) x 70/30) = 2.55
iii) New Cost of equity, ke = Rf + beta x MRP = 4% + 2.55 x 5% = 16.74%
WACC = wd x kd x (1 - tax) + we x ke = 70% x 6% x (1 - 20%) + 30% x 16.74% = 8.38%
iv) Increase in debt = 20% x 30 = $6 million
Shares repurchased = 6 / 30 = 0.2 million
Remaining shares = 0.5 - 0.2 = 0.3 million
v) Value = EBIT x (1 - tax) / WACC = 8.5 x (1 - 20%) / 8.38% = $81.12 million
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