WACC and Company Valuation Mini Case Study Brian Jones is a30-year-old managing director of Full Charge Corporation. Recentlypromoted to the role upon the retirement of his father, he is thethird generation of his family to run the business. HistoricallyFull Charge Corporation had been a significant player in the marketfor battery production for diesel and petrol fuelled vehicles. Morerecently, the business has pivoted toward addressing demand forbatteries used in electric vehicles. Despite strong and steadyprofitability in recent years, Full Charge’s share price had beenrelatively stagnant at around $25 per share. Brian felt that thiswas in part due to the financial policies followed by his father,which he viewed as overly conservative. Full Charge Corporationhave historically been 100% equity financed with no debt in thecapital structure. Full Charge Corporation are active in theproduction of a technology that will help reduce environmentallyharmful emissions and thus they benefit from a major tax break.More specifically, they pay zero corporation tax. Noting thatunconventional monetary policies had supressed yields (and thuslowered borrowing costs) in the aftermath of the financial crisis,Brian proposed that Full Charge make a significant change to itscapital structure. He proposed that the company buy back $500m ofits outstanding shares using cash raised by issuing new debt. Heestimated that the cost of this debt would be around 4% based onprevailing market yields on the debt of firms with similar levelsof credit quality. Brian was confident that this policy would makeshareholders (of which he was one) better off. In aggregate, thosewho sold would receive $500m in cash, but Brian projected the shareprice for the remaining shareholders would also rise as a result ofhis actions. Historically Full Charge had a policy of returning allcompany profits to shareholders in the form of a dividend, andBrian was clear that this policy should continue. Whilst reducingthe share-count would mean that in aggregate less dividends wouldbe distributed, he was confident that the dividend paid per sharewould increase. His accounting department prepared the followingbasic set of pro forma financial statements for the coming year(for the all equity-financed firm)… Full Charge Corp Pro- FormaFinancial Statement All figures (except per share) in $m SharesOutstanding Measured in Millions Income Statement Revenue 1500Operating Expenses 1375 Operating Profit 125 Net Income 125Dividends 125 Shares Outstanding 62.5 Dividends Per Share 2.00Balance Sheet Current Assets 450 Fixed Assets 550 Total Assets 1000Total Debt 0 Total Equity 1000 Total Capital 1000 Inflation wascurrently running at close to zero. Revenue and operating expenseswere thus projected to remain at the same amount per yearindefinitely. Brian observed that the company’s equity beta wasaround 0.8 whilst the market risk premium was around 5%. Heestimated the current cost of equity of the no-debt firm as 8%. Onthe basis of an estimated cost of debt of 4%, Brian argued that anyincrease in debt would lead to a lowering of the company’s capitalcost. He thought “If we aggressively seek the best deals for rawmaterials, why shouldn’t we extend the same philosophy to ourcapital?” Brian’s colleague and MBA graduate, Amanda, expressedsome concerns about the restructuring. Firstly, she asserted thatthe proposed action might boost EPS, however adding debt to thecapital structure would magnify the sensitivity of EPS to changesin operating profit. Furthermore, she expressed doubt as to whetheror not the restructuring would have the share price impact Brianpredicted. Provide some financial analysis to help support Amanda’sline of reasoning. (For ease of exposition, assume that there areneither distress costs nor signalling value associated with capitalstructure decisions). Given the growth in the market for electricvehicles, the government is weighing up whether to drop the taxexemption enjoyed by Full Charge Corporation. More specifically,there is debate about the introduction of a 20% corporation taxrate for companies in this market. What would this proposed taxchange mean for the post restructuring weighted average cost ofcapital (WACC) and the share price of Full Charge? (For thescenario where corporate taxes apply, assume that thepost-restructuring share count equals 39.4m). Again, assume thereare neither distress costs nor signalling implications associatedwith capital structure decisions. Explain the underlying mechanismsthat lead to any changes in the WACC and share price.