Capital structureShow calculation steps1. A firm is solely financed by equity with market value of $50,000 and cost of equity of 10%. It wishes to raise another $30,000 via corporate bonds with cost of debt of 5% and use all of it to buy back outstanding equity (no cash holding). Hold investment policies fixed. a)In a MM world without taxes, i.What would the firm value be after debt issuance? Firm Value = Equity Value + Debt Value - Cash. ii.What would be the cost of equity after debt is raised? iii.What would be the WACC after debt is raised? b)In a MM world with tax rate of 40%, i.What would be the cost of equity after debt is raised? ii.What would be the additional value created by debt? iii.What would be the WACC after debt is raised?
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.
Capital structureShow calculation steps1. A firm is solely financed by equity with market value of $50,000 and
a)In a MM world without taxes,
i.What would the firm value be after debt issuance? Firm Value = Equity Value + Debt Value - Cash.
ii.What would be the cost of equity after debt is raised?
iii.What would be the WACC after debt is raised?
b)In a MM world with tax rate of 40%,
i.What would be the cost of equity after debt is raised?
ii.What would be the additional value created by debt?
iii.What would be the WACC after debt is raised?
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