XYZ firm is proposing the following scenario regarding its capital structure. Th
ID: 2618006 • Letter: X
Question
XYZ firm is proposing the following scenario regarding its capital structure. The firm, as first stage, has no debt in its capital structure, however, the firm can borrow at cost of debt equal to 8%. If the firms, WACC now is 12% and the corporate tax rate is 35%, then with no debts, what is the firms cost of equity. what will be the firms cost of equity if it uses 25% as debt, and what will be the firms WACC what will be the firms cost of equity if it uses 50% as debt, and what will be the firms WACC 1- 2- 3-Explanation / Answer
1)
With no debts, cost of equity is equal to the current WACC of 12%
2)
Cost of equity:
Cost of levered equity = cost of unlevered equity + ( cost of unlevered equity - cost of debt )( 1 - tax) debt/equity ratio
Cost of levered equity = 0.12 + ( 0.12 - 0.08)( 1 - 0.35) 0.25/0.75
Cost of levered equity = 0.12 + 0.008666
Cost of levered equity = 0.128666 or 12.87%
WACC = weight of equity * cost of equity + weight of debt * after tax cost of debt
WACC = 0.75 * 0.1287 + 0.25 * 0.12 *(1 - 0.35)
WACC = 0.096525 + 0.0195
WACC = 0.116025 or 11.6%
3)
Cost of equity:
Cost of levered equity = cost of unlevered equity + ( cost of unlevered equity - cost of debt )( 1 - tax) debt/equity ratio
Cost of levered equity = 0.12 + ( 0.12 - 0.08)( 1 - 0.35) 0.5/0.5
Cost of levered equity = 0.12 + 0.026
Cost of levered equity = 0.146 or 14.6%
WACC = weight of equity * cost of equity + weight of debt * after tax cost of debt
WACC = 0.5 * 0.146 + 0.5 * 0.12 *(1 - 0.35)
WACC = 0.073 + 0.039
WACC = 0.112 or 11.2%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.