Omega Corporation has 10 million shares outstanding, now trading at $55 per share. The firm has estimated the expected rate of return to shareholders at about 12%. It has also issued $200 million of long-term bonds at an interest rate of 7%. It pays tax at a marginal rate of 35%. a. What is Omega's after-tax WACC? b. How much higher would WACC be if Omega used no debt at all? (Hint: For this problem you can assume that the firm's overall beta [BA] is not affected by its capital structure or by the taxes saved because debt interest is tax-deductible.)
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.
![Omega Corporation has 10 million shares outstanding, now trading at $55 per share.
The firm has estimated the expected rate of return to shareholders at about 12%. It
has also issued $200 million of long-term bonds at an interest rate of 7%. It pays tax
at a marginal rate of 35%. a. What is Omega's after-tax WACC? b. How much higher
would WACC be if Omega used no debt at all? (Hint: For this problem you can
assume that the firm's overall beta [BA] is not affected by its capital structure or by
the taxes saved because debt interest is tax-deductible.)](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F3c1b79bd-ec90-48fd-be7a-92b723031db9%2Facc054c8-209c-4876-8042-cf0237306411%2Ff8ebgyc_processed.jpeg&w=3840&q=75)
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 2 images
