Cars Corporation currently has 15% debt in its capital structure; however, its n
ID: 1175722 • Letter: C
Question
Cars Corporation currently has 15% debt in its capital structure; however, its new CFO is considering changing the capital structure to 30% debt. The company has 4% annual coupon bonds outstanding that have a before-tax yield to maturity of 6%. Additional financial information is given below.
Risk-free rate, rRF 2.50%
Tax rate, T 25%
Market risk premium (rM - rRF) 5.00%
Current beta, bL 1.1
a. What is the company's WACC at its existing 15% debt ratio?
b. What would be the company's levered beta if it increased its debt ratio to 30%? Carry your answer out to 4 decimal places.
Explanation / Answer
1-
after tax cost of debt
YTM*(1-tax rate)
6*(1-.25)
4.5
cost of equity
risk free rate+(market risk premium)*beta
2.5+(5)*1.1
8
WACC
source
weight
cost
weight*cost
debt
0.15
4.5
0.675
equity
0.85
8
6.8
WACC
sum of weight*cost
7.48
2-
levered beta
unlevered beta*(1+(1-tax rate)*(debt/equity)
1.1*(1-(1-.25)*30%/70%))
0.7464
1-
after tax cost of debt
YTM*(1-tax rate)
6*(1-.25)
4.5
cost of equity
risk free rate+(market risk premium)*beta
2.5+(5)*1.1
8
WACC
source
weight
cost
weight*cost
debt
0.15
4.5
0.675
equity
0.85
8
6.8
WACC
sum of weight*cost
7.48
2-
levered beta
unlevered beta*(1+(1-tax rate)*(debt/equity)
1.1*(1-(1-.25)*30%/70%))
0.7464
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