In an M&M world with taxes, Roll Inc. is an all equity firm with an unlevered return of 16%. The value of the unlevered firm is $9,375,000. There are 500,000 shares outstanding. They want to alter their capital structure by issuing $1,600,000 in debt that will be used to repurchase stock. The return on debt is 7%. Tax rate is 25%. a) Find the cost of equity after the capital structure change. b) How many shares can they repurchase?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
In an M&M world with taxes, Roll Inc. is an all equity firm with an unlevered return of 16%. The value of the unlevered firm is $9,375,000. There are 500,000 shares outstanding. They want to alter their capital structure by issuing $1,600,000 in debt that will be used to repurchase stock. The return on debt is 7%. Tax rate is 25%.
a) Find the
b) How many shares can they repurchase?
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