Question
3. General Motors Inc., a producer of turbine generators, is in this situation: EBIT= $4 million, tax rate, T= 35%, Debt outstanding = D =
3. General Motors Inc., a producer of turbine generators, is in this situation: EBIT= $4 million, tax rate, T= 35%, Debt outstanding = D = $2 million, Cost of Debt = 10%, Cost of Equity = 15%, common shares outstanding = 600,000, and book value per share = $10 and the market value per share = $27.40. Since product market is stable and the company expects no growth, all earnings are paid out as dividend. The debt consists of perpetual bonds. (a) What is the companys weighted average cost of capital (WACC)? [3 Marks] (b) General Motors can increase its debt by $8 million, to a total of $10 million, using the new debt ($8 million) to buy back and retire some of its shares immediately at the given market price. Its new interest rate on debt will be 12% (it will have to call and refund the old debt), and its cost of equity will rise from 15% to 17%. EBIT will remain constant. Should General Motors change its capital structure?
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