Question
Willard Pest Control (WPC) currently has a capital structure, based on market values, of 50% debt. The debt consists of 8% perpetual bonds selling at
Willard Pest Control (WPC) currently has a capital structure, based on market values, of 50% debt. The debt consists of 8% perpetual bonds selling at par. The company's EBIT is $7.25 million, and its tax rate is 15%. WPC can change its capital structure by either increasing its debt to 70% (based on market values) or decreasing it to 30%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 10% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 7% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change.
The firm pays out all earnings as dividends; hence, its stock is a zero-growth stock. Its current cost of equity, rs , is 11%. If it increases leverage, rs, will be 13%. If it decreases leverage, rs will be 10.5%. What is the firm's WACC and total corporate value under each capital structure?
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