J Ltd. is an all equity financed company with a market value of 25,00,000 and cost of equity (K e ) 21%. The company wants to buyback equity shares…

Market Value of Equity = 25,00,000 K e = 21% Net income (NI) for equity - holders = Market Value of Equity x K e Net income (NI) for equity holders = 25,00,000 x 0.21 = 5,25,000 EBIT = Net income for equity holders / (1 - Tax Rate) EBIT = 5,25,000 / 0.7 = 7,50,000 All Equity Debt and Equity EBIT 7,50,000 7,50,000 Interest to debt-holders - (75,000) EBT 7,50,000 6,75,000 Taxes (30%) (2,25,000) (2,02,500) Income available to equity shareholders 5,25,000 4,72,500 Income to debt holders plus income available to shareholders 5,25,000 5,47,500 Present value of tax-shield benefits = 5,00,000 × 0.30 = 1,50,000 (i) Value of Restructured firm = 25,00,000 +1,50,000 = 26,50,000 (ii) Cost of Equity (K e ) Total Value = 26,50,000 Less: Value of Debt = 5,00,000 Value of Equity = 21,50,000 K e = Income available to equity shareholders / Value of Equity K e = 4,72,500 / 21,50,000 = 0.219 = 21.98% (iii) WACC (on market value weight) Cost of Debt (after tax) = 15% (1- 0.3) = 0.15 (0.70) = 0.105 = 10.5% Components of Costs Amount Cost of Capital (%) Weight WACC (%) Equity 21,50,000 21.98 0.81 17.80 Debt 5,00,000 10.50 0.19 2.00 26,50,000 19.80 Comment: At present the company is all equity financed. So, K e = K o i.e. 21%. However, after restructuring, the K o would be reduced to 19.80% and K e would increase from 21% to 21.98%.