1) If a firm is unlevered and has a cost of equity capital 9%, what would the co

Question

1) If a firm is unlevered and has a cost of equity capital 9%, what would the cost of equity be if the firms became levered at a debt-equity ratio of 5? The expected cost of debt is 7%. (Assume no taxes.)
2)
a)Learn and Earn Company is financed entirely by Common stock that is priced to offer a 29% expected return. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the expected return on the common stock after refinancing?
b)Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. If the company repurchases 50% of the stock and substitutes an equal value of debt yielding i=0.06, what is the expected earnings per share value after refinancing?

Explanation / Answer

1.Cost of Debt=7%

Cost of Equity=X%

% of Equity=1/6=0.16667

% of Debt=5/6=0.8333

The Weighted Average Cost of Capital, or WACC is the measure of the cost of capital, or hurdle rate used to measure the minimum required return investors expect to earn to invest in a new project.

The formula is:

WACC=(Cost of Debt*% of Debt Investment out of the whole investment)+(Cost of Equity*% of Equity Investment)

9%=(7%*0.16667)+(X%*0.16667)

9%=5.8331+ (x%*0.16667)

x%=19%

2.

a.)Using the same method as in 1:

.5*.08+x*.5=.29

x=.5 or 50%

b)

Using the same method as in 1:

.5*.06+x*.5=.20

x=.34 or 34%

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