A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 Tax rate Debt in the capital structure EBIT Interest Profit before taxes Taxes Profit after taxes Dividends Total payments to security holders Required return on debt Required return on equity Market value of debt Market value of equity Market value of the firm Book value of debt Book value of equity Book value of the firm Return on total capital Return on equity Number of shares outstanding Price per share Earnings per share Price-earnings ratio Book value debt ratio Market value debt ratio Weighted average cost of capital Free cash flow Market value of the firm
B 0% 0% 120,000 120,000 120,000 120,000 120,000 8.00% 12.00% 1,000,000 1,000,000 500,000 500,000 24.0% 24.0% 5,000 200.0 24.00 8.33 0.0% 0.0% 12.0% 120,000 1,000,000
C
D
E
F
G
10% 120,000 4,125 115,875 115,875 115,875 120,000 8.25% 12.50% 50,000 927,000 977,000 50,000 450,000 500,000 24.0% 25.8% 4,744 195.4 24.43 8.00 10.0% 5.1% 12.3% 120,000 977,000
20% 120,000 8,750 111,250 111,250 111,250 120,000 8.75% 13.00% 100,000 855,769 955,769 100,000 400,000 500,000 24.0% 27.8% 4,477 191.2 24.85 7.69 20.0% 10.5% 12.6% 120,000 955,769
30% 120,000 14,625 105,375 105,375 105,375 120,000 9.75% 13.50% 150,000 780,556 930,556 150,000 350,000 500,000 24.0% 30.1% 4,194 186.1 25.13 7.41 30.0% 16.1% 12.9% 120,000 930,556
40% 120,000 22,000 98,000 98,000 98,000 120,000 11.00% 14.50% 200,000 675,862 875,862 200,000 300,000 500,000 24.0% 32.7% 3,858 175.2 25.40 6.90 40.0% 22.8% 13.7% 120,000 875,862
50% 120,000 31,250 88,750 88,750 88,750 120,000 12.50% 16.00% 250,000 554,688 804,688 250,000 250,000 500,000 24.0% 35.5% 3,447 160.9 25.75 6.25 50.0% 31.1% 14.9% 120,000 804,688
Note: The number of shares and price per share are computed from the following considerations. Assume the change from 0% debt to any other amount of debt is accomplished by repurchasing shares with the borrowed funds. Then the price per share times the number of shares repurchased must equal the amount borrowed. Also, the price per share times the number of shares remaining must equal the market value of equity. Together, these imply that the price per share times 5000 must equal the market value of the firm. This fact is used to compute the price per share and then the number of shares is found by dividing the market value of equity by the price per share.
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CALCULATION OF WACC FOR 10% DEBT Data from Exhibit 1 Market value debt ratio Cost of debt Cost of equity Tax rate 5.12% 8.25% 12.50% 0% Weighted Costs 0.42% 11.86% 12.28%
Weights After-tax cost of debt Cost of equity WACC 8.25% 12.50% 5.12% 94.88%