Healthy Foods' balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.25%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 24%. What is the effect of the capital structure change on the WACC of the firm? Please use excel
Old WACC
D/E = MV debt/(share*price)
=27/(10*20)
=0.135
| D/A = D/(E+D) |
| D/A = 0.135/(1+0.135) |
| =0.1189 |
| Weight of equity = 1-D/A |
| Weight of equity = 1-0.1189 |
| W(E)=0.8811 |
| Weight of debt = D/A |
| Weight of debt = 0.1189 |
| W(D)=0.1189 |
| After tax cost of debt = cost of debt*(1-tax rate) |
| After tax cost of debt = 8*(1-0.24) |
| = 6.08 |
| WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
| WACC=6.08*0.1189+12.25*0.8811 |
| WACC =11.52% |
New WACC
| Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate) |
| 12.25 = Unlevered cost of equity+0.135*(Unlevered cost of equity-8)*(1-0.24) |
| Unlevered cost of equity = 11.85 |
| Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate) |
| Levered cost of equity = 11.85+0.53846*(11.85-8)*(1-0.24) |
| Levered cost of equity = 13.43 |
new D/E = (D/A)/(1-(D/A))
=0.35/(1-0.35) = 0.53846
| Weight of equity = 1-D/A |
| Weight of equity = 1-0.35 |
| W(E)=0.65 |
| Weight of debt = D/A |
| Weight of debt = 0.35 |
| W(D)=0.35 |
| After tax cost of debt = cost of debt*(1-tax rate) |
| After tax cost of debt = 8*(1-0.24) |
| = 6.08 |
| WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
| WACC=6.08*0.35+13.43*0.65 |
| WACC =10.86% |
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