Kyma Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company isconsidering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used torepurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would causethe required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would theWACC change, i.e., what is WACCold - WACCNew?New Debt/Assets35%Orig. cost of equity, rs10.0%New Equity/Assets65%New cost of equity = rs11.0%Interest rate new = rd 7.0%Tax rate40.0%O1.72%O2.06%1.38%1.04%

WACC is the overall average cost of the all sources of the finance. It is equal to the sum of…

Answered: Kyma Inc. currently has zero debt. It…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter3: Evaluation Of Financial Performance

Section: Chapter Questions

Problem 12QTD

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David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during the next 3 years: FCF2 = 290,000 and FCF3 = 320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is 128,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.
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Gator Fabrics Inc. currently has zero debt (i.e., wd = 0). It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCOld − WACCNew?
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