The Nantucket Nugget's current debt-to-equity ratio is 40% and pays no taxes. The firm currently has $4 million worth of debt outstanding. Nantucket is considering increasing its debt-to-equity ratio to 50%. To achieve this goal, it will issue additional debt with an 8% interest rate and repurchase shares of stock with the proceeds of the debt issue. 

 

1. What is the market value of the firm before and after the share repurchase? How much new debt the firm must issue to achieve its goal?            
2. If the firm's expected cost of equity before the share repurchase is 12%, what will Nantucket's new expected cost of equity be (after share repurchase)?
3. Will the firm's WACC change after the share repurchase?  Why or why not? 
4. If the firm has a tax rate of 35%, describe how would this change your answers in parts a) and c).

Answer rating: 100% (QA)

Lets go step by step to answer each part of the question a Market value of the firm before and after the share repurchase Before the share repurchase ... View the full answer