Crosby Industries has a debt-equity ratio of 1.2. Its WACC is 14 percent, and it

Question

Crosby Industries has a debt-equity ratio of 1.2. Its WACC is 14 percent, and its cost of debt is 9 percent. There is no corporate tax.

What is Crosby’s cost of equity capital? (Do not round intermediate calculations. Input your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What would the cost of equity be if the debt-equity ratio were 2? (Do not round intermediate calculations. Input your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What would the cost of equity be if the debt-equity ratio were 0.6? (Do not round intermediate calculations. Input your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What would the cost of equity be if the debt-equity ratio were zero? (Do not round intermediate calculations. Input your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Crosby Industries has a debt-equity ratio of 1.2. Its WACC is 14 percent, and its cost of debt is 9 percent. There is no corporate tax.

Explanation / Answer

Given that cost of debt is 0.09 and weighted average cost of capital is 0.14

Requirement 1:

Since the debt equity ratio is mentioned as 1.2, I take it that the ratio is 1.2:1. Accordingly, the calculations are as follows:

Therefore, cost of equity capital is 0.0909/0.455 x 100 = 19.98%

Requirement 2:

If the debt equity ratio was 2: 1, what is cost of equity capital?

Similarly, the cost of equity capital is 0.080/0.333 x 100 = 24.02%

Requirement 3:

If the debt equity ratio was 0.6, what is cost of equity capital?

Therefore cost of equity capital is 0.10625/0.625 x 100 = 17%

Requirement 4:

If the debt equity ratio is zero, the cost of equity is 14%

Source of capital Ratio Weights Specific cost of capital Weighted average cost of capital Equity 1 1/2.2 =0.455 ? 0.0909 Debt 1.2 1.2/2.2 = 0.545 0.09 0.545 x 0.09 =0.0491 2.2 1.000 0.14

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