A company with no debt, worth $10 billion with 100 million shares at $100, borrows $1 billion at 6% to pay a special dividend. What happens to its WACC, enterprise value, equity value and share price?

Give all four first: WACC dips, enterprise value is flat or up by the tax shield, equity value falls about $1 billion and the price drops about $10. Holders keep the dividend, so they gain the shield, about $2.50 a share.

The numbers, step by step

The company from the question, in $ millions, at a 25% tax rate. It makes $1,000 of unlevered cash flow a year with no growth, so a 10% WACC gives the $10,000.

Dividend per share$1,000 ÷ 100 million shares

$10

Tax saved on interest each year$1,000 × 6% × 25%

$15

Value of the tax shield25% × $1,000 of permanent debt

$250

Enterprise value after$10,000 + $250

$10,250

Equity value after$10,250 − $1,000 of debt

$9,250

Share price after$9,250 ÷ 100 million shares

$92.50

Value per share with the dividend$92.50 + $10

$102.50

Cost of equity after10% + (10% − 6%) × 75% × 1/9

10.33%

WACC after90% × 10.33% + 10% × 4.5%

9.75%

What the interviewer listens for

• Do you give all four answers in one line before the detail?
• Do you use the bridge: equity down $1 billion, debt up $1 billion?
• Do you count the $10 dividend in what shareholders hold?
• Do you show the cost of equity rising while WACC falls?
• Do you name the tax shield as the gain and high leverage as the limit?

Common mistakes

• Saying enterprise value falls by $1 billion.Equity falls and debt rises by the same amount, so it's flat or up slightly.
• Arguing WACC rises because the cost of equity rises.At moderate leverage the cheaper after-tax debt more than offsets it.
• Treating the drop to about $92.50 as a loss, when holders also have the $10 dividend.
• Claiming more debt always lowers WACC.Past moderate leverage, the costs of debt and equity rise fast enough to push it back up.

Likely follow-ups

• What happens to EPS?With no debt today, net income equals the $1 billion of cash flow. After-tax interest of $45 million takes EPS from $10.00 to $9.55 on the same 100 million shares.
• What if it used the $1 billion to buy back shares instead?Enterprise value and equity value move the same way. Buying at about $102.50 retires about 9.8 million shares and the price stays near $102.50, the same gain delivered in the price.
• What if it borrowed $6 billion instead?The debt would be priced like high yield and distress costs would start to bite, so WACC turns back up and the recap would likely destroy value.

More finance technicals

• Walk me through a DCF.
• What is WACC and how do you calculate it?
• What is the difference between enterprise value and equity value?
• How would you value a company?
• Two companies have the same earnings but trade at different P/E multiples. Why?

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