Question

Answer the next 3 questions based on this information

Despite having a near-monopolistic market position, poor management and operational practices have left the Nautical Boating Network Corporation (NBN Co for short) significantly underfunded and needing to raise more capital. Because of its monopolistic position, debt holders are willing to lend NBN an additional $100 million, at a 1% premium to their current before-tax cost of debt of 4%. (This cost of debt of 5% will apply to all company debts after the debt raising). Even with its questionable management team, the additional debt is not expected to increase the risk of financial distress for NBN. The current market value of NBN’s assets are $300 million and the current Debt to Equity ratio is 0.5. NBN has a current cost of equity of 8% and is subject to a 30% corporate tax rate.

What is NBN’s current before-tax WACC?

6.67%

7.00%

6.00%

6.50%

If NBN’s unlevered cost of equity is currently 7.2%, what will be the new cost of equity after the debt raising?

12.00%

10.25%

11.00%

9.40%

If NBN’s cost of equity after the debt raising is 10%, what will be the after-tax WACC after the debt raising?

6.75%

5.81%

6.65%

6.17%

6.20%

Answer 1

Current assets = $300 million

Debt Value = 300 Million *DE Ratio / (1 + DE Ratio)

Debt Value = 300 Million *0.50/ 1.50

Debt Value = 100 Million

Equity Value = 200 Million

1. Current Before tax WACC = Cost of debt * Weight of debt + Cost of Equity * Weight of Equity

Current Before tax WACC = 4% * 0.50/1.50 + 8% * 1/1.50

Current Before tax WACC = 0.0133 + 0.0534

Current Before tax WACC = 6.67% Option A

2. Levered Cost of Equity = Unlevered cost of equity + New DE ratio *( Unlevered cost of equity - Cost of debt)

Levered Cost of Equity = 7.20% + 1 *( 7.20% - 5%)

Levered Cost of Equity = 9.40% Option D

New Debt value = 100 Million + 100 Million = 200 M

New Equity value = 200 M

3. After tax WACC after new Debt Issue

Cost of debt * (1 - Tax) * Weight of debt + Cost of Equity * Weight of Equity

5% * (1 - 0.30) * 0.50 + 10% * 0.50

6.75% Option A

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