Question

1. Roger Inc. is currently an all equity firm that has 500,000 shares of stock outstanding at a market price of $20 a share. EBIT is $1,500,000 and is constant forever. The required annual rate of return on the share is 12%. The corporate tax is 35%. The firm is proposing borrowing an additional $2 million in debt and uses the proceeds to repurchase stock. If it does so, the cost of debt will be 10%. What will be the WACC after the capital structure changes?

Answer 1

No. of shares	500,000
Stock Price	20
Total Equity value	10,000,000
EBIT	1,500,000
Unleverd cost of equity	12%
Tax rate	35%
Debt Raised	2,000,000
Cost of debt	10%
No of shares repurchased	Debt raised/stock price	=100,000
New equity value	shares remaining*stock price	=8,000,000
New D/E Ratio	0.25
WACC formula	WACC = WD*RD *(1-T) + WE*RE
	1. W = the respective weight of debt and equity in the total capital structure.
	2. T = tax rate.
	3. D = cost of debt.
	4. P = cost of preferred stock/equity.
	5. E = cost of equity
WACC	10.9%

The above table shows the case facts and WACC due to debt raised by the company.

The cost of equity also changes due to change in equity beta as the firm becomes levered. Thus we need additional information regarding the firm unleverd beta also to compute the exact WACC.

Kindly reach out to me in case of further clarifications.