A

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Tax rate

0%

Debt in the capital structure

0%

10%

20%

30%

40%

50%

EBIT
Interest
Profit before taxes
Taxes
Profit after taxes
Dividends

120,000
120,000
120,000
120,000

120,000
4,125
115,875
115,875
115,875

120,000
8,750
111,250
111,250
111,250

120,000
14,625
105,375
105,375
105,375

120,000
22,000
98,000
98,000
98,000

120,000
31,250
88,750
88,750
88,750

Total payments to security holders

120,000

120,000

120,000

120,000

120,000

120,000

8.00%
12.00%
1,000,000
1,000,000

8.25%
12.50%
50,000
927,000
977,000

8.75%
13.00%
100,000
855,769
955,769

9.75%
13.50%
150,000
780,556
930,556

11.00%
14.50%
200,000
675,862
875,862

12.50%
16.00%
250,000
554,688
804,688

500,000
500,000

50,000
450,000
500,000

100,000
400,000
500,000

150,000
350,000
500,000

200,000
300,000
500,000

250,000
250,000
500,000

Required return on debt

Required return on equity
Market value of debt
Market value of equity
Market value of the firm
Book value of debt
Book value of equity
Book value of the firm
Return on total capital
Return on equity

24.0%
24.0%

24.0%
25.8%

24.0%
27.8%

24.0%
30.1%

24.0%
32.7%

24.0%
35.5%

Number of shares outstanding

Price per share
Earnings per share
Price-earnings ratio

5,000
200.0
24.00
8.33

4,744
195.4
24.43
8.00

4,477
191.2
24.85
7.69

4,194
186.1
25.13
7.41

3,858
175.2
25.40
6.90

3,447
160.9
25.75
6.25

0.0%
0.0%

10.0%
5.1%

20.0%
10.5%

30.0%
16.1%

40.0%
22.8%

50.0%
31.1%

12.0%
120,000
1,000,000

12.3%
120,000
977,000

12.6%
120,000
955,769

12.9%
120,000
930,556

13.7%
120,000
875,862

14.9%
120,000
804,688

Book value debt ratio

Market value debt ratio
Weighted average cost of capital
Free cash flow
Market value of the firm

Note: The number of shares and price per share are computed from the following considerations.
Assume the change from 0% debt to any other amount of debt is accomplished by repurchasing
shares with the borrowed funds. Then the price per share times the number of shares repurchased
must equal the amount borrowed. Also, the price per share times the number of shares remaining
must equal the market value of equity. Together, these imply that the price per share times 5000
must equal the market value of the firm. This fact is used to compute the price per share and then
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
Cost of debt
Cost of equity
Tax rate

5.12%
8.25%
12.50%
0%

Weights
After-tax cost of debt
Cost of equity
WACC

8.25%
12.50%

5.12%
94.88%

Weighted
Costs
0.42%
11.86%
12.28%