Wallet Drug Company has just recently raised money abroad for the first time in the history of the firm. Prior to the recent equity issue abroad, the firm had a D/V ratio of 40%, an effective tax rate of 30%, a before-tax cost of debt of 9%, and a domestic beta of 1.3. The expected return on the market portfolio was 13% and the risk-free rate was 5%. After the equity issue, Wallet Drug has a D/V ratio of 50%, their after-tax cost of debt has not changed, nor has the effective tax rate, the firm's international beta is 1.0, the expected return on the market portfolio is only 12%, and the risk-free rate is still 5%. What was the firm's WACC prior to the issue of new common stock abroad?

Question

Quizplus · Accepted Answer

Before the equity issue, D/V ratio = 40%, E/V ratio = 60%.

Beta = 1.3.

Re = Rf + Beta * (Rm - Rf) = 5% + 1.3 * (13% - 5%) = 15.4%.

After-tax cost of debt = 9% * (1 - 30%) = 6.3%.

WACC = (E/V * Re) + (D/V * Rd * (1 - Tc))

= (0.6 * 15.4%) + (0.4 * 6.3% * (1 - 30%))

= 11.76%.

Therefore, the firm's WACC prior to the issue of new common stock abroad was 11.76%.

Wallet Drug Company Has Just Recently Raised Money Abroad for the First