a. Hose plc presently has a capital structure which is 30 per cent debt and 70 per cent equity. The cost of debt (i.e. borrowings) before tax shield benefits is 9 per cent and that for equity is 15 per cent. The firm's future cash flows, after tax but before interest, are expected to be a perpetuity of £750,000. The tax rate is 30 per cent.
Calculate the WACC and the value of the firm.
b. The directors are considering the partial replacement of equity finance with borrowings so that the borrowings make up 60 per cent of the total capital. Director A believes that the cost of equity capital will remain constant at 15 per cent; Director B believes that shareholders will demand a rate of return of 23.7 per cent; Director C believes that shareholders will demand a rate of return of 17 per cent and Director D believes the equity rate of return will shift to 28 per cent. Assuming that the cost of borrowings before income taxes remains at 9 per cent, what will the WACC and the value of the firm be under each of the directors' estimates?