Question

14. Cisco Systems currently has 1 million shares outstanding worth $10 per share, and a capital structure that consists of 30% debt at a 5% interest rate. Cisco is considering purchasing Clark Technology, which has 500,000 shares outstanding worth $8.50 each and no debt. Clark’s cost of equity is 11 percent and Cisco System’s cost of equity is 12%. If, after the purchase, Cisco recapitalizes Clark Technology to have the same capital structure as Cisco, with debt at the same interest rate, what will be Clark’s WACC? Both firms face a 25% tax rate.

Answer 1

Answers :-

Weighted Avarage Cost of Capital (WACC) = 8.825%

Explanations :-

Weighted Avarage Cost of Capital (WACC) = (Cost of Equity × Weightage) + (after tax cost of debt × Weight)

before tax cost of debt = 5%

tax rate = 25%

after tax cost of debt = 5% × (1 - 0.25)

= 5% × 0.75

after tax cost of debt = 3.75%

weight = 30%

Cost of Equity = 11%

Weight = (1 - 30%) = 70%

Weighted Avarage Cost of Capital (WACC) = (3.75% × 0.30) + (11% × 0.70)

   = 1.125% + 7.7%

Weighted Avarage Cost of Capital (WACC) = 8.825%