Crosby Industries has a debt-equity ratio of 1.1. Its WACC is 13 percent, and it

Question

Crosby Industries has a debt-equity ratio of 1.1. Its WACC is 13 percent, and its cost of debt is 4 percent. There is no corporate tax. a. What is the company's cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity b. What would the cost of equity be if the debt-equity ratio were 2? (Do not round intermediate calculations and enter your answer as a percent rounded to the nearest whole number, e.g., 32.) 0 Cost of equity 0 What would the cost of equity be if the debt-equity ratio were.5? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity What would the cost of equity be if the debt-equity ratio were zero? (Do not round intermediate calculations and enter your answer as a percent rounded to the nearest whole number, e.g., 32.) 0 Cost of equity 0

Explanation / Answer

a.

Debt Equity ratio = Debt / Equity = 1.1

Say Debt = x

x / 1-x = 1.1

x = 1.1-1.1x

2.1x = 1.1

x = 0.5238

i.e Weight of Debt = 52.38%

Weight of Equity = 47.62% (100%-52.38%)

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity = 13%

0.04 * 0.5238 + Cost of Equity * 0.4762 = 0.13

  Cost of Equity = 22.89%

b.

If debt equity ratio = 2

Say Debt = x

x / 1-x = 2

x = 2-2x

3x = 2

x = 0.67

i.e Weight of Debt = 67%

Weight of Equity = 33% (100%-67%)

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity = 13%

0.04 * 0.67 + Cost of Equity * 0.33 = 0.13

  Cost of Equity = 31.27%

If debt equity ratio = 0.5

Say Debt = x

x / 1-x = 0.5

x = 0.5-0.5x

1.5x = 0.5

x = 0.33

i.e Weight of Debt = 33%

Weight of Equity = 67% (100%-33%)

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity = 13%

0.04 * 0.33 + Cost of Equity * 0.67 = 0.13

  Cost of Equity = 17.43%

If debt equity ratio = 0

i.e Weight of Debt = 0%

Weight of Equity = 100%

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity = 13%

0.04 * 0 + Cost of Equity * 1 = 0.13

  Cost of Equity = 13%

i.e debt equity ratio is 0, WACC = Cost of equity

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