Williamson, Inc., has a debt-to-equity ratio of 2.43. The firm’s weighted averag

Question

Williamson, Inc., has a debt-to-equity ratio of 2.43. The firm’s weighted average cost of capital is 11 percent, and its pretax cost of debt is 5 percent. Williamson is subject to a corporate tax rate of 30 percent.

What is Williamson’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).)

What would Williamson’s weighted average cost of capital be if the firm’s debt-to-equity ratio were .65 and 1.80? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)

PLEASE ANSWER ALL Question A, B and C!

Williamson, Inc., has a debt-to-equity ratio of 2.43. The firm’s weighted average cost of capital is 11 percent, and its pretax cost of debt is 5 percent. Williamson is subject to a corporate tax rate of 30 percent. a. What is Williamson’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 29.22 % b. What is Williamson’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 7.66 % c. What would Williamson’s weighted average cost of capital be if the firm’s debt-to-equity ratio were .65 and 1.80? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).) Weighted average cost of capital Debt–equity ratio .65 % Debt–equity ratio 1.80 %

Williamson, Inc., has a debt-to-equity ratio of 2.43. The firm’s weighted average cost of capital is 11 percent, and its pretax cost of debt is 5 percent. Williamson is subject to a corporate tax rate of 30 percent.

Explanation / Answer

(a) CALCULATION OF COST OF EQUITY CAPITAL(KE)

GIVEN,

WEIGHTED AVERAGE COST OF CAPITAL(WACC)=11%

DEBT TO EQUITY RATIO=2.43 I.E WHERE DEBT IS 2.43 EQUITY=1

TOTAL OF DEBT AND EQUITY=2.43+1=3.43

WEIGHT OF DEBT(WD)=2.43/3.43=0.7085

WEIGHT OF EQUITY(WE)=1/3.43=0.2915

COST OF DEBT (KD)=5%(PRETAX)

AFTER TAX KD =5%(1-TAX RATE)

=5%(1-0.3)

=3.5%

APPLYING FORMULA,

WACC=KD*WD+KE*WE

11%=3.5%*0.7085+KE*0.2915

KE*0.2915=11%-2.47975

=8.52025

KE=29.23%

HENCE COST OF EQUITY CAPITAL IS 29.23%

(b) CALCULATION OF COST OF UNLEVERED EQUITY CAPITAL

(c)CALCULATION OF WEIGHTED AVERAGE COST OF CAPITAL

WHEN DEBT EQUITY RATIO IS 0.65

APPLYING FORMULA,WACC=KD*WD+KE*WE

KD=3.5 CALCULATED ABOVE

WD=WEIGHT OF DEBT=0.65/(0.65+1)=0.65/1.65=0.3939

KE=29.23% CALCULATED ABOVE

WE=WEIGHT OF EQUITY=1/1.65=0.6060

HENCE WEIGHTED AVERAGE COST OF CAPITAL IS=3.5*0.3939+29.23*0.6060

=19.09%

WHEN DEBT EQUITY RATIO IS 1.8

APPLYING FORMULA,WACC=KD*WD+KE*WE

KD=3.5%

WD=1.8/(1.8+1)=0.6429

KE=29.23%

WE=1/(1.8+1)=0.3571

HENCE WEIGHTED AVERAGE COST OF CAPITAL=3.5%*0.6429+29.23%*0.3571

=12.69%

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