Twice Shy Industries has a debtequity ratio of 1.4. Its WACC is 8 percent, and i

Question

Twice Shy Industries has a debtequity ratio of 1.4. Its WACC is 8 percent, and its cost of debt is 5.9 percent. The corporate tax rate is 35 percent.

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.)

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.)

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.)

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.)

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.)

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.)

Explanation / Answer

Answer:

a.     With the information provided, we can use the equation for calculating WACC to find the cost of equity. The equation for WACC is:

         WACC = (E/V)RE + (D/V)RD(1 – tC)

         The company has a debt-equity ratio of 1.4, which implies the weight of debt is 1.4/2.4, and the weight of equity is 1/2.4, so

         WACC = .08 = (1/2.4)RE + (1.4/2.4)(.059)(1 – .35)

         RE = .1383 or 13.83%

b.    To find the unlevered cost of equity we need to use M&M Proposition II with taxes, so:

         RE = RU + (RU – RD)(D/E)(1 – tC)

         .1383 = RU + (RU – .059)(1.4)(1 – .35)

         RU = .1003 or 10.03%

c.     To find the cost of equity under different capital structures, we can again use the WACC equation. With a debt-equity ratio of 2, the cost of equity is:

         .08 = (1/3)RE + (2/3)(.059)(1 – .35)   

         RE = .1633 or 16.33%

         With a debt-equity ratio of 1.0, the cost of equity is:

         .08 = (1/2)RE + (1/2)(.059)(1 – .35)     

         RE = .1216 or 12.16%

         And with a debt-equity ratio of 0, the cost of equity is:

         .08 = (1)RE + (0)(.059)(1 – .35)      

         RE = WACC = .08 or 8%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.