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Acort Industries has 10 million shares outstanding and a current share price of $40 per share. It also has long-term debt outstanding. This debt is risk free, is four years away from maturity, has annual coupons with a coupon rate of 10%, and has a $100 million face value. The first of the remaining coupon payments will be due in exactly one year. The riskless interest rates for all maturities are constant at 6%. Acort has EBIT of $106 million, which is expected to remain constant each year. New capital expenditures are expected to equal depreciation and equal $13 million per year, while no changes to net working capital are expected in the future. The corporate tax rate is 40%, and Acort is expected to keep its debt-equity ratio constant in the future (by either issuing additional new debt or buying back some debt as time goes on).

a. We dont know Acorts equity cost of capital, so we cannot calculate WACC directly. However, we can compute it indirectly by estimating the discount rate that is consistent with Acorts market value. First, E = 10 40 = $400 million. The market value of Acorts debt is 4 4 D 10 1 1 1 100 $113.86 million. 0.06 1.06 1.06 = + = Therefore, Acorts enterprise value is E + D = 400 + 113.86 = 513.86. Acorts FCF = EBIT(1 C ) + Dep Capex Inc in NWC FCF = 106 (1 0.40) = 63.6 Because Acort is not expected to grow, L wacc V 513.86 63.6 r = = and so wacc r 63.6 12.38%. 513.86 = = b. Using wacc E D c r E r D r (1 ) E D D E = + + + , E 12.38% 400 r 113.86 6%(1 0.40) 513.86 513.86 = + solving for rE: E r 513.86 12.38% 113.86 6%(1 0.40) 14.88%.

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