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West Coast Industries currently has a capital structure, based on market values of 50% debt. The debt is a bond issued with a 4.5% coupon rate. The firm's EBIT is $12 million and it's tax rate is 15%. WCI can change its capital structure by either increasing it's debt to 70% (based on market values) or decrease it to 35%. If WCI decides to increase its use of leverage, it must call in its old bonds and replace them with new bonds that have a 6.5% coupon rate. The company will either sell or repurchase stock at the new equilibrium price to complete the change in its capital structure.
The firm pays out all earnings as dividends,- hence, its stock is a zero-growth stock. The current cost of equity is 10%. If it increases leverage, their cost of equity would be 13%. If it decreases leverage the cost of equity would be 10.5%. What is the firm's WACC and total corporate value under each capital structure?
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