The common stock and debt of Northern Sludge are valued at $60 million and $40 m
ID: 2650444 • Letter: T
Question
The common stock and debt of Northern Sludge are valued at $60 million and $40 million, respectively. Investors currently require a 17.0% return on the common stock and a 7.0% return on the debt. If Northern Sludge issues an additional $24 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
New return on equity %
The common stock and debt of Northern Sludge are valued at $60 million and $40 million, respectively. Investors currently require a 17.0% return on the common stock and a 7.0% return on the debt. If Northern Sludge issues an additional $24 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
New return on equity %
Explanation / Answer
At present WACC=
since there is no change in capital structure after new issue of stock the overall wacc will remain same = 13%
so 1.12 +.84X= 13
X=13-1.12
=11.88%
So new return on equity = 11.88%
**Debt = 40-24 = 16
Equity = 60+24 = 84
weights Return weighted return Debt .40 40/[40+60] 7 2.80 equity .60 60/[40+60] 17 10.20 WACC 13