Question

Zimmer Biomet Corporation in Warsaw Indiana produces orthopedic devices (artificial hips, knees, and shoulders). The WACC at the end of 2017 when the corporate tax rate was 35%, was 8.73%. President Trump’s new tax plan lowers the corporate tax rate to 21% in 2018. Zimmer Biomet’s Board of Directors has decided that the want to keep the WACC the same in 2018 by changing the Debt to Equity ratio. Assume: Rd = 0.08, Re = 0.13, and the original debt to equity ratio (in 2017) was 0.5. What does the new, 2018, Debt to Equity ratio need to be?

Answer 1

Let the Weight of Debt be "X" so weight of equity be (1-x)

WACC : [After tax debt *Weight of debt] + [cost of equity *weight of equity]

8.73 = [8(1-.35)*x]+ [13*(1-x)]

8.73 = 5.2x+ 13-13x

8.73 = -7.8x +13

x = (13-8.73 ) /7.8

       = 4.27/7.8

weight of debt = .5474

Weight of equity = 1-.5474 = .4526

Debt to equity ratio = Debt /equity

           = .5474 /.4526

              = 1.21