Question
In: Finance
Oren Manis Berhad has a capital structure that consists of RM2 million of debt, and RM11...
Oren Manis Berhad has a capital structure that consists of RM2 million of debt, and RM11 million of common equity, based upon current market values from its 2,000,000 shares. The company’s yield to maturity on its bonds is 7%, and investors require a 14% return on common stock.
- Oren Manis Berhad can increase its debt by RM8.0 million and using the new debt to buy back the shares at current price. Its interest rate on the new debt will be the same as its earlier debt and its costs of new equity will rise from 14% to 17%. EBIT will remain constant. Should Oren Manis Berhad change its capital structure?
Solutions
Expert Solution
Calculation of weight of debt in the current capital structure.
= Debt /(Debt + Equity)
= 2/(2+11)
= 0.1538
Calculation of weight of Equity in the current capital structure.
= Equity /(Debt + Equity)
= 11/(2+11)
= 0.8642
Given cost of Debt is 7 % and cost of equity is 14%
WACC with current capital structure.
| Source | Weight | Cost | Weighted Cost |
| Debt | 0.1538 | 7.00% | 1.08% |
| Equity Stock | 0.8462 | 14.00% | 11.85% |
| WACC | 12.92% |
Calculation of weight of debt in the new capital structure.
= Debt / (Debt + Equity)
= 10 (2Existing + 8 New)/(10 (New Debt )+ 3 new equity (11old equity - 8 Redeemed part))
= 10/13
= 0.7692
Calculation of weight of Equity in the new capital structure.
= Equity/ (Debt + Equity)
= 3 (10+3)
= 0.2308
New cost of equity is 17%
WACC with new capital structure.
| Source | Weight | Cost | Weighted Cost |
| Debt | 0.7692 | 7.00% | 5.38% |
| Equity Stock | 0.2308 | 17.00% | 3.92% |
| WACC | 9.31% |
Capital structure should be changed since WACC is reducing with captial structure.
Please let me know incase of further assistance
jeff jeffy answered 2 years agoRelated Solutions
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