Fawlty Brake Systems Inc. is all equity financed and generates perpetual annual EBIT of $600. Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year. Assume that Fawlty has a 100% payout rate, 1,000 shares outstanding, and that shareholders require a return of 6%. Assume that the tax rate is 0%.
Fawlty is considering an open market stock repurchase. It plans to buy 20% of its outstanding shares at the price of $10.00 per share. The repurchased shares will be cancelled. It will finance the repurchase by issuing perpetual bonds worth a total sum of $2,000 and a coupon rate (and yield) of 4%. Assume that the tax rate is 0%.
If Fawlty goes ahead with the repurchase, then what is its WACC after the repurchase is complete?
◦ 4.0%
◦ 4.5%
◦ 5.0%
◦ 5.5%
◦ 6.0%
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