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Debt, Equity, WACC

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An all equity firm has a required return on its equity of 15%, has 10 million shares outstanding, and pays no taxes. The shares are currently trading at $6.00 each. The firm is planning to borrow $9 million at 5% interest rate and use the borrowed funds to buyback a portion of its equity. Calculate the new value of the firm and the new required return on its equity if it goes through with the capital structure change.

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Solution Summary

In this solution Value of the firm and the WACC is calculated after introduction of debt into the capital structure.

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What is the debt-equity and WACC for Acetate Inc.?

Acetate Inc. has equity with a market value of $20 million and debt with a market value of $10 million. The cost of the debt is 14 percent per annum. Treasury bills that mature in one year yield 8 percent per annum, and the expected return on the market portfolio over the next year is 18 percent. The beta of Acetate's equity is 0.9. The firm pays no taxes.

a. What is Acetate's debt-equity ratio?
b. What is the firm's weighted average cost of capital?
c. What is the cost of capital for an otherwise identical all-equity firm?

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