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Baxter has historically maintained a debt-equity ratio of approximately 0.25. The firm enjoys very stable...

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Accounting

  1. Baxter has historically maintained a debt-equity ratio of approximately 0.25. 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%. Baxters tax rate is 40%. Current market value of Baxter (including debt and equity) is 120 m. The company is expected to have free cash flows of $10 billion in perpetuity

Baxter 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%.

  1. Determine Baxters rWACC before the recapitalization and rA
  2. If Baxter announces that it will raise its debt-equity ratio to 0.5 through a leveraged recapitalization, determine its new WACC
  3. Determine the increase in the company value that would result from the anticipated tax savings.

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