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Sample Q & A Chapter: Leverage & Capital Restructuring: Before Restructuring After Restructuring

The document contains 3 sample questions regarding leverage and capital restructuring. Question 1 calculates the value of a company before and after issuing debt, the cost of equity before and after, and the weighted average cost of capital (WACC) before and after. Question 2 calculates the unlevered and levered value of a company after borrowing, the value of equity, cost of equity, and WACC after leverage. Question 3 calculates the cost of equity and WACC for a company financing expansion through 20% debt, and describes how WACC would change if debt increased to 60%.

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149 views3 pages

Sample Q & A Chapter: Leverage & Capital Restructuring: Before Restructuring After Restructuring

The document contains 3 sample questions regarding leverage and capital restructuring. Question 1 calculates the value of a company before and after issuing debt, the cost of equity before and after, and the weighted average cost of capital (WACC) before and after. Question 2 calculates the unlevered and levered value of a company after borrowing, the value of equity, cost of equity, and WACC after leverage. Question 3 calculates the cost of equity and WACC for a company financing expansion through 20% debt, and describes how WACC would change if debt increased to 60%.

Uploaded by

nur fatin
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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SAMPLE Q & A

CHAPTER: LEVERAGE & CAPITAL RESTRUCTURING

QUESTION 1
MicroChip Company has estimated earnings before interest and tax (EBIT) of RM6,000 in perpetuity. The
unlevered cost of capital is 26% and there are 30,000 shares outstanding. In preparing for future
expansion program, the company is considering issuing new debt to add some financial leverage. The
cost of debt is expected to be 12%.

i) Differentiate the value of the company before and after the restructuring, assuming the tax
rate is 34% and RM10,000 debt is issued.
ii) Differentiate the cost of equity before and after restructuring.
iii) Differentiate the weighted average cost of capital (WACC) before and after restructuring.

Before restructuring After restructuring

i) Value of the Vu = EBIT (1-tax) / Ru VL = Vu + (debt x tax rate)


company = 6,000 (1-0.34) / 0.26 =15,230.77 + (10,000 x 0.34)
= RM15,230.77 = RM18,630.77

ii) Cost of Re = 26% Re = Ru + (Ru –Rd ) D/E (1 – tax rate)


equity = 0.26 + (0.26–0.12) 10,000 / 8,630.77 (1– 0.34)
= 36.71%

Where E = VL – D
= 18,630.77 – 10,000
= RM8,630.77

iii) WACC WACC = 26% WACC = E/V (Re) + D/V (Rd) (1-tax rate)
= 8,630.77 (0.3671) + 10,000 (0.12) (1-0.34)
18,630.77 18,630.77
= 21.26%

QUESTION 2
Mekar Auto Bhd has earnings before interest and taxes of RM149,000. The company plans to borrow
RM265,000 from a bank that charge 9% interest in order to finance its new venture with an auto parts
dealer. Currently, the firm’s unlevered cost of equity is 13.5% and tax rate is 34%. Calculate:
i) The unlevered and levered value of the company
ii) The value of the equity after leverage
iii) Cost of equity after leverage
iv) WACC after leverage

i) Vu = EBIT x ( 1 – tax rate)


Ru
Vu = 149,000 x ( 1 – 0.34)
0.135
= RM728,444.44

VL = Vu + (Debt x tax rate)


VL = 728,444.44 + (0.34 x RM265,000)

1
= RM818,544.44

ii) E = VL - D
= RM818,544.44 - RM265,000
= RM553,544.44

iii) Re = Ru + ( Ru– Rd) x D x ( 1 – tax rate)


E
Re = 0.135 + ( 0.135 – 0.09) x 2650,000 x ( 1 – 0.35)
553,544.44
= 14.92%

iv) WACC = E (Re) + D (Rd) x ( 1 – tax rate)


V V
= [(553,544.44 X 0.1492] + [(265,000) X 0.09 (1 - .34)]
818,544.44 818,544.44
= 12.01%

QUESTION 3
Power Supply Bhd’s cost of equity is 14%. Its EBIT is currently at RM725,250 a year. The company is
going to set up a new factory that cost RM5 million to increase its productivity. Power Supply Bhd’s, an
unlevered firm expects to include 20% debt that costs 9% per annum in order to finance the expansion. At
present the company pays 32% tax rate.

i) Calculate the cost of equity of the firm after restructuring.


ii) What is the firm’s WACC after restructuring?
iii) Explain what will happen to the WACC if the firm introduces 60% debt to its capital structure?

i) Re = Ru + (Ru –Rd ) D/E (1 – tax rate)


= 0.14 + (0.14 –0.09 ) 0.20/0.80 (1 – 0.32)
= 0.1485 or 14.85%

ii) WACC = E/V (Re) + D/V (Rd) (1-tax rate)


= 80% (0.1485) + 20%(0.09) (1-0.32)
= 0.1310 or 13.10%

iii) WACC = E/V (Re) + D/V (Rd) (1-tax rate)


= 40% (0.1910) + 60%(0.09) (1-0.32)
= 0.1131 or 11.31%

Calculate Re = Ru + (Ru –Rd ) D/E (1 – tax rate)


= 0.14 + (0.14 –0.09 ) 0.60/0.40 (1 – 0.32)
= 0.1910 or 19.10%

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