Problem Based on Chapter 15 – Wacc and the Hamada Formula

PROBLEM BASED ON CHAPTER 15 – WACC AND THE HAMADA FORMULA
Bickley Engineering Company has a capital structure of 30% Debt and 70% Equity. Its current Beta is 1.3, and its Market Risk Premium is 7.5% Points. The current Risk Free Rate is 3.5%. Bickley’s marginal tax rate is 40%.
What is the Unlevered Beta of Bickley?
Bickley’s management would like to change its capital structure to 15% Debt and 85% equity by retiring its bonds yielding 8%. The remaining long term debt will be at 7%. The marginal tax rate will remain the same.
What will be Bickley’s new Beta with this new 15/85 capital structure?
What is the WACC (Weighted Average Cost of Capital) of Bickely with its 30/70 capital structure? Bickley’s average borrowing rate with this capital structure is 7.5%.
What will be Bickley’s WACC with its 15/85 capital structure? CHAPTER 15
1. Unlevered Beta of Bickely
Bu = 1.3 / [1 + (1 - .40)(.30/.70)] = 1.03 2. Beta with 15/85 capital structure
B = 1.03 [1 + (1 - .40)(.15/.85)] = 1.14 3. WACC with 30/70 capital structure, avg borrowing rate 7.5%
Cost of equity = .035 + (.075)(1.3)= 0.1325
WACC = [.30 x .075 x (1 - .40)] + [.70 x .1325] = 0.10625 10.63% 4. WACC with 15/85 capital structure
Cost of equity = .035 + (.075)(1.14)= 0.1205
WACC = [.15 x .07 x (1 - .40)] + [.85 x .1205] = 0.108725 10.87%

CHAPTER 26
1. Unlevered Value of Yancey
Vu = 2.0 miillion x (1 + .065)/(.115 - .065) = 42.60 $42.6 million 2. VL, $8.0 million debt costing 8%
VL = $42.6 million + [.08 x .35 x $8 million / (.115 - .065)] = 47.08 $47.08 million rsL = .115 + (.115 - .08)[8 million / (47.08 million - 8 million)] = 0.12216479 12.22% 3. VL & rsL by using the M&M Model (with taxes)
VL = 42.6 million + (.35 x 8 million) = 45.4 $45.4 million
S = 45.4 - 8 = 37.4 rsL = .115 + (.115 -.08)(1 - .35)(8/37.4) = 0.11986631