1. Prokter and Gramble (PG) has historically maintained a debt-equity ratio of approximately 0.20. Its current stock price is $50 per share, with 2.5 billion shares outstanding. The firm enjoys very stable demand for its products, and consequently can borrow at 4.20%, just 20 basis points over the risk-free rate of 4%. PG’s tax rate is 35%. PG’s current asset return (rA) is 6.35%
PG believes it can increase debt without any serious risk of distress or other costs. With a higher debt-equity ratio of 0.50, it believes its borrowing costs will rise only slightly to 4.50%.
a) If PG announces that it will raise its debt-equity ratio to 0.5 through a leveraged recapitalization, determine new WACC
b) PG is expected to have free cash flows of $6.0 billion in perpetuity. Determine the increase in the company value that would result from the anticipated tax savings.