Hatter, Inc., has equity with a market value of $23.2 million and debt with a ma

Question

Hatter, Inc., has equity with a market value of $23.2 million and debt with a market value of $11.6 million. The cost of debt is 8 percent per year. Treasury bills that mature in one year yield 4 percent per year, and the expected return on the market portfolio over the next year is 10 percent. The beta of the company's equity is 1,17 The firm pays no taxes e.9.32.16.)y's o. What is the company's debt-equity ratio? (Do not round intermediate calculations and round your answer to 2 decimal places, Debt-equity ratio b. What is the company's weighted average cost of capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Weighted average cost of capital -7% c. What is the cost of capital for an otherwise Identical all-equity firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g, 32.16.) Cost of capital %

Explanation / Answer

a. Debt-to-equity ratio=Debt/Equity ie. 11.6/23.2= 0.5 50% b.Wt. Av. Cost of Capital= WACC=(Wt.E*Ke)+(Wt.D*kd) ie. (Wt.of equity*Cost of equity)+(Wt. of debt*Cost of debt) Wt. of equity =Market Value of Equity/Total market value of Firm ie. 23.2/(23.2+11.6)= 66.67% Or calculating from the above debt-Equity ratio: D/E=0.5 ,ie. 0.5/1 So, Wt.of Equity to total weight of (Debt+equity)= 1/(0.5+1)=1/1.5= 66.67% Cost of Equity , ke: As per CAPM Cost of Equity=RFR+(Beta*Market Risk premium) where, Market risk premium= Expected market return-RFR So, Ke= 4%+(1.17*(10%-4%))= 11.02% Wt. of Debt =Market Value of Debt/Total market value of Firm ie. 11.6/(23.2+11.6)= 33.33% Or calculating from the above debt-Equity ratio: D/E=0.5 ,ie. 0.5/1 So, Wt.of Debt to total weight of (Debt+equity)= 0.5/(0.5+1)=0.5/1.5= 33.33% Cost of Debt , kd: Given: the firm pays no taxes So, kd= 8% Now, the WACC= WACC=(Wt.E*Ke)+(Wt.D*kd) ie.(66.67%*11.02%)+(33.33%*8%)= 10.01% c. Cost of capital for an all-equity firm = 11.02%

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