Question
1. (35 points) Your firm wants to decrease its use of debt in order to increase its operating flexibility. Currently, the firm has $50 million
1. (35 points) Your firm wants to decrease its use of debt in order to increase its operating flexibility. Currently, the firm has $50 million in debt outstanding, $50 million common equity. The firm wants to raise enough common equity to repurchase $10 million in bonds that have very restrictive covenants. The firm also wants to raise $25 million in common equity to fund a new project (project C) that will also replace a current project (project B). You need to determine by how much WACC will change if the firm takes these actions. The firms debt beta is 0.3 and the cost of debt is 8%. The market return is 15% and the risk-free rate is 5%. The firm has only two projects currently. The firm has invested $20 million in project A, which has a beta of 1.2. The firm has invested $80 million in project B. The firm wants to shut down project B, shifting that money to project C, and invest an additional $25 million in project C, which has a beta of 1.56. The firms common equity currently has a correlation of 0.7 with the market, and a standard deviation of 71.7, but this is subject to change when the firm changes its characteristics. The markets variance is 400. The tax rate is 40%. If the changes will not change the debt beta/cost of debt, by how much will the WACC change?
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