Suppose the cost of equity of an unlevered firm is 10.0%. The firm is currently...
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Suppose the cost of equity of an unlevered firm is 10.0%. The firm is currently considering changing its capital structure. In particular, it is considering changing its debt-to-value ratio to 60% by issuing debt and using the proceeds to buy back shares. The firm can borrow at 4%. Suppose the firm goes ahead with this.
Note: Unless otherwise stated, assume that markets are perfect and complete. For the WACC, use the after-tax cost of debt.
(a) Suppose that the corporate tax rate is 25% and interest payments are tax deductible. There are no personal taxes. What is the best estimate of the firm's weighted average cost of capital (WACC) after the capital structure change?
(b)Suppose that the corporate tax rate is 25% and interest payments are tax deductible. The personal tax rate is the same for debt and equity and is 10%. What is the best estimate of the firm's weighted average cost of capital (WACC) after the capital structure change?
(c)The firm's cost of borrowing is not given. Suppose that the corporate tax rate is 25% and that the personal tax rate on equity is 0%. Suppose the Miller equilibrium holds. What is the best estimate of the firm's weighted average cost of capital (WACC) after the capital structure change?
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