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# Cost of equity in a levered firm

Rayburn Manufacturing, Inc., is currently an all-equity firm that pays no taxes. The market value of the firm's equity is \$2 million. The cost of this unleveraged equity is 18 percent per annum. Rayburn plans to issue \$400,000 in debt and use the proceeds to repurchase stock. The cost of debt is 10 percent per annum.

After Rayburn repurchases the stock, what will the firm's weighted average cost of capital be?
After the repurchase, what will the cost of equity be? Explain.
Use your answer to (b) to compute Rayburn's weighted average cost of capital after the repurchase. Is this answer consistent with (a)?

#### Solution Preview

Rayburn Manufacturing, Inc., is currently an all-equity firm that pays no taxes. The market value of the firm's equity is \$2 million. The cost of this unlevered equity is 18 percent per annum. Rayburn plans to issue \$400,000 in debt and use the proceeds to repurchase stock. The cost of debt is 10 percent per annum.

Since there are no tax advantages of debt, the cost of capital before and after the repurchase would remain the same.

a. After Rayburn repurchases the stock, what will the firm's weighted average cost of capital be?

Since there are no tax advantages of debt, the cost of capital before and after the ...

#### Solution Summary

Calculates the weighted average cost of capital and cost of equity after repurchase of stock using debt.

\$2.19