Burdell Scientific Incorporated finances its operations with $40 million in stock with a required return of 12 percent and $10 million in bonds with a required return of 6 percent.Suppose the firm issues $15 million in additional bonds at 8 percent,using the proceeds to retire $15 million worth of equity.If the WACC remains the same,what will be the firm's new cost of equity? (Assume zero taxes and perfect capital markets)

Question

Quizplus · Accepted Answer

Old WACC:
Rs = R + (R - Rd)* D/E = .12 = R + (R - .06)* $10/$40
.12 = R + .25 R - .015
R = (.12+.015)/1.25 = .1080
New Rs:
Rd = $10/$25*.06+$15/$25*.08=.072
Rs = R + (R - Rd)* D/E
Rs = .1080 + (.1080 - .072)* $25/$25 = .1080 + .036 = .144

Burdell Scientific Incorporated Finances Its Operations with $40 Million in Stock