A B C D E F G

1 Tax rate 0%
2
3 Debt in the capital structure 0% 10% 20% 30% 40% 50%
4
5 EBIT 120,000 120,000 120,000 120,000 120,000 120,000
6 Interest - 4,125 8,750 14,625 22,000 31,250
7 Profit before taxes 120,000 115,875 111,250 105,375 98,000 88,750
8 Taxes - - - - - -
9 Profit after taxes 120,000 115,875 111,250 105,375 98,000 88,750
10 Dividends 120,000 115,875 111,250 105,375 98,000 88,750
11
12 Total payments to security holders 120,000 120,000 120,000 120,000 120,000 120,000
13
14 Required return on debt 8.00% 8.25% 8.75% 9.75% 11.00% 12.50%
15 Required return on equity 12.00% 12.50% 13.00% 13.50% 14.50% 16.00%
16 Market value of debt - 50,000 100,000 150,000 200,000 250,000
17 Market value of equity 1,000,000 927,000 855,769 780,556 675,862 554,688
18 Market value of the firm 1,000,000 977,000 955,769 930,556 875,862 804,688
19
20 Book value of debt - 50,000 100,000 150,000 200,000 250,000
21 Book value of equity 500,000 450,000 400,000 350,000 300,000 250,000
22 Book value of the firm 500,000 500,000 500,000 500,000 500,000 500,000
23
24 Return on total capital 24.0% 24.0% 24.0% 24.0% 24.0% 24.0%
25 Return on equity 24.0% 25.8% 27.8% 30.1% 32.7% 35.5%
26
27 Number of shares outstanding 5,000 4,744 4,477 4,194 3,858 3,447
28 Price per share 200.0 195.4 191.2 186.1 175.2 160.9
29 Earnings per share 24.00 24.43 24.85 25.13 25.40 25.75
30 Price-earnings ratio 8.33 8.00 7.69 7.41 6.90 6.25
31
32 Book value debt ratio 0.0% 10.0% 20.0% 30.0% 40.0% 50.0%
33 Market value debt ratio 0.0% 5.1% 10.5% 16.1% 22.8% 31.1%
34
35 Weighted average cost of capital 12.0% 12.3% 12.6% 12.9% 13.7% 14.9%
36 Free cash flow 120,000 120,000 120,000 120,000 120,000 120,000
37 Market value of the firm 1,000,000 977,000 955,769 930,556 875,862 804,688
38
39 Note: The number of shares and price per share are computed from the following considerations.
40 Assume the change from 0% debt to any other amount of debt is accomplished by repurchasing
41 shares with the borrowed funds. Then the price per share times the number of shares repurchased
42 must equal the amount borrowed. Also, the price per share times the number of shares remaining
43 must equal the market value of equity. Together, these imply that the price per share times 5000
44 must equal the market value of the firm. This fact is used to compute the price per share and then
45 the number of shares is found by dividing the market value of equity by the price per share.

Page 1
CALCULATION OF WACC FOR 10% DEBT

Data from Exhibit 1

Market value debt ratio 5.12%

Cost of debt 8.25%
Cost of equity 12.50%
Tax rate 0%

Weighted
Weights Costs

After-tax cost of debt 8.25% 5.12% 0.42%

Cost of equity 12.50% 94.88% 11.86%
WACC 12.28%