Question 24 Unsaved The Flintex Corporation FC currently has

Question 24 Unsaved The Flintex Corporation (FC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6%. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. FC\'s current cost of equity is 8.8%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00. The firm is considering moving to a capital structure that is comprised of 40% debt and 60% equity, based on market values. The new funds would be used to replace the old debt and to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on debt to rise to 7%, while the required rate of return on equity would rise to 9.5%. If this plan were carried out, what would be FC\'s new WACC and total value? Question options:

a) 7.80%; $790,008

b) 7.50%; $790,008

c) 7.38%; $813,008

d) 7.38%; $800,008

Solution

Option D

1. Computation of New WACC

New WACC = Weight of Debt * Cost of Debt * (1 - Tax Rate) + Cost of Equity * Weight of equity

New WACC = 0.40 * 0.07 * (1 - 40%) + 0.095 * 0.60

New WACC = 0.0168 + 0.057

New WACC = 7.38%

2. Market Value = Market Value of Debt + Market Value of Equity

Market Value = $200000 + 10000 * $60

Market Value = $800000