Calculating WACC under New Capital Structure

CFA Level II
#1

Let’s say you want to lever up the capital structure of a company by issuing more debt to fund share buy backs.

Assume your debt is currently 10000 and your equity is 20000. Your current D/(D+E) = 1/3 You want to raise 5000 in additional debt to fund share buyback. This would mean that the new D/(D+E) = 1/2

When you calculate the WACC, you have to take the weighted proportion of the cost of debt and and cost of equity. Do you the 1/3 for the cost of debt weight or 1/2?

The confusing thing is the share buybacks because equity reduces in the capital structure and debt increases.

#2

You would use 1/2 since thats the targeted or proposed capital structure (15000 debt and 15000 equity).

#3

Yeah, somewhere in the cirriculum it says to use the Target capital structure when calculating WACC, even if the current state isn’t at target. No clue where it says that, though. It all blends together after a while…lol

Now, if the quesiton was asking to comapre before and after WACC, obvioulsy you need to do both, but there would be more info given than what is in your post.

#4

Its in the Equity readings…the section on Return.