Twice Shy Industries has a debtequity ratio of 1.6. Its WACC is 8.6 percent, and

Question

Twice Shy Industries has a debtequity ratio of 1.6. Its WACC is 8.6 percent, and its cost of debt is 6.1 percent. The corporate tax rate is 35 percent.

a. What is the company’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 %

b. What is the company’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 capital %

c-1 What would the cost of equity be if the debtequity ratio were 2? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

c-2 What would the cost of equity be if the debtequity ratio were 1.0? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

c-3 What would the cost of equity be if the debtequity ratio were zero? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

Explanation / Answer

Calculation of debt equity ratio. Given debt equity ratio = 1.6 Formula for Debt Equity ratio = Debt / Equity It means Equity = 1 Debt = 1.6 Total value (Equity+Debt) = 2.6 Tax rate 35% Cost of Equity Cost of Debt 6.10% WACC 8.60% A Weighted average cost of capital = Equity / Value * cost of equity + Debt / Value * (cost of debt - Tax rate ) 8.6% = 1 / 2.60 * Cost of equity + 1.60 / 2.60 * (6.10 - 35% ) 8.6% = 0.384 * Cost of equity + 0.6153 * 3.965 8.6% = 0.384 * Cost of equity + 2.439 Cost of equity 8.60 - 2.439 / 0.384 Cost of equity 16% C - 1 If the Debt equity ratio is 2, then the cost of equity will be. Given debt equity ratio = 2 Formula for Debt Equity ratio = Debt / Equity It means Equity = 1 Debt = 2 Total value (Equity+Debt) = 3 Weighted average cost of capital Equity / Value * cost of equity + Debt / Value * (cost of debt - Tax rate ) 8.6% = 1 / 3 * Cost of equity + 2 / 3 * (6.10 - 35% ) 8.6% = 0.33 * Cost of equity + 0.66 * 3.965 8.6% = 0.33 * Cost of equity + 2.6169 Cost of equity 8.60 - 2.6169 / 0.33 Cost of equity 18.13% C - 2 If the Debt equity ratio is 1, then the cost of equity will be. Given debt equity ratio = 1 Formula for Debt Equity ratio = Debt / Equity It means Equity = 1 Debt = 1 Total value (Equity+Debt) = 2 Weighted average cost of capital Equity / Value * cost of equity + Debt / Value * (cost of debt - Tax rate ) 8.6% = 1 / 2 * Cost of equity + 1 / 2 * (6.10 - 35% ) 8.6% = 0.50 * Cost of equity + 0.50 * 3.965 8.6% = 0.50 * Cost of equity + 1.9825 Cost of equity 8.60 - 1.9825 / 0.50 Cost of equity 13.24% C - 3 If the Debt equity ratio is 0, then the cost of equity will be. Given debt equity ratio = 0 Formula for Debt Equity ratio = Debt / Equity It means Equity = 1 Debt = 0 Total value (Equity+Debt) = 1 Weighted average cost of capital Equity / Value * cost of equity + Debt / Value * (cost of debt - Tax rate ) 8.6% = 1 / 1 * Cost of equity + 0 / 1 * (6.10 - 35% ) 8.6% = 1 * Cost of equity + 0 * 3.965 8.6% = 1 * Cost of equity + 0 Cost of equity 8.60 - 0 / 1 Cost of equity 8.60%

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