Williamson, Inc., has a debt-equity ratio of 2.49. The company\'s weighted avera

Question

Williamson, Inc., has a debt-equity ratio of 2.49. The company's weighted average cost of capital is 11 percent, and its pretax cost of debt is 5 percent. The corporate tax rate is 30 percent a. What is the company's cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g. 32.16.) Cost of equity capital [ 2963% b. What is the company's unlevered cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g. 32.16.) unlevered cost of equity 1% c. What would the weighted average cost of capital be f the company's debt-equity ratio were 60 and 150? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Weightec average cost of capital Debt-equity ratio.60 Debt-equity ratio 1.50

Explanation / Answer

1)

Weight of equity = 1 / 1 + 2.49 = 1 / 3.49 = 0.286533

Weight of debt = 1 - 0.286533 = 0.713467

After tax cost of debt = 0.05 ( 1 - 0.3) = 0.035 or 3.5%

WACC = weight of equity * cost of equity + weight of debt * cost of debt

0.11 = 0.286533 * cost of equity + 0.713467 * 0.035

0.085029 = 0.286533 * cost of equity

cost of equity = 0.29675 or 29.68%

2)

Cost of levered equity = cost of unlevered equity + ( cost of unlevered equity - cost of debt)(1 - tax)debt-equity ratio

0.2968 = cost of unlevered equity + ( cost of unlevered equity - 0.05)( 1 - 0.3)2.49

0.2968 = cost of unlevered equity + 1.743cost of unlevered equity - 0.08715

0.38395 = 2.743cost of unlevered equity

cost of unlevered equity = 0.139974 or 14%

3)

if debt equity ratio was 0.6

weight of equity = 1 / 1.6 = 0.625

weight of debt = 0.375

cost of levered equity = 0.14 + ( 0.14 - 0.05)( 1 - 0.3)0.6

cost of levered equity = 0.14 + 0.0378

cost of levered equity = 0.1778 or 17.78%

WACC = 0.625 * 0.1778 + 0.375 * 0.035

WACC = 0.111125 + 0.013125

WACC = 0.12425 or 12.43%

if debt equity ratio was 1.5

weight of equity = 1 / 2.5 = 0.4

weight of debt = 0.6

cost of levered equity = 0.14 + ( 0.14 - 0.05)( 1 - 0.3)1.5

cost of levered equity = 0.14 + 0.0945

cost of levered equity = 0.2345 or 23.45%

WACC = 0.4 * 0.2345 + 0.6 * 0.035

WACC = 0.0938 + 0.021

WACC = 0.1148 or 11.48%

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