Question

Firm Z is the result of a merger between firm X and firm Y. Firm X was paying 2.50% on its debt and had a beta of 2.2. Firm Y was paying 3.50% on its debt and had a beta of 25. Firm X had 800 M$ assets and 30%-70% equity-debt structure while Firm Y had 200 MS assets and 20%-80% equity-debt structure. 1. What is the WACC of firm Z knowing that the size of the new entity allowed it to have a cost of debt of 1.5%and to have a beta of 1.75, and that the market where the three firms evolve has a premium of 6% and a risk free rate of 1.5%? 2. How does the WACC for Z compare to the WACC of X and Y? How do you explain this finding?

Note : show the results in Details Please ( How did they Came )

Answer 1

Answer 1)

	X	Y	Z
Total Asset value	800	200	1000
Debt	70%	80%
	560	160	720	560+160
Debt weight in Z			0.72	720/1000
Equity	30%	20%
	240	40	280	240+40
equity weight in Z			0.28	280/1000
Cost of debt	2.50%	3.50%	1.50%
Beta	2.2	2.5	1.75
Risk Free rate	1.50%	1.50%	1.50%
Market risk premium	6%	6%	6%
Cost of equity	Risk free + Beta* market Premium
Cost of equity	9.300%	9.750%	8.625%
	6%+2.2*1.5%	6%+2.5*1.5%	6%+1.75*1.5%
WACC	Cost of equity*weight of equity+Cost of debt*weight of debt
WACC	4.540%	4.750%	3.495%
	9.3%*0.3+2.5%*0.7	9.75%*0.2+3.5%*0.8	8.625%*0.28+1.5%*0.72

Answer 2) The WACC for Z is less than X and Y company, calculated as above.