Twice Shy Industries has a debtequity ratio of 1.2. Its WACC is 9 percent, and i

Question

Twice Shy Industries has a debtequity ratio of 1.2. Its WACC is 9 percent, and its cost of debt is 5.7 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 24.53 % 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 16.14 % 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

RE = 15.55%

B)

(c)

RE = .198 I , e 19.81

(d)

debt equity ratio = 1.2 wacc = 9% cost of debt = 5.7 % corporate tax rate = 35% calculate cost of equity capital: with the information provided , we can use the equation for calculating wacc to find out the cost of equity. The equation for wacc is: WACC = [(E/V) x Re] + [((D/V) x Rd) x (1-Tc)]. the company has a debt equity of 1.2 which implies that weight of debt is ( 1.2/2.2) and weight of equity is ( 1/2.2) wacc = .09 = ( 1/ 2.2) RE + ( 1.2/2.2) (.057)(1-0.35)

RE = 15.55%

B)

Calculation for unlevered cost of equity : RE = RU + (RU – RD)(D/E)(1 – tC) 0.1555 = RU + ( RU - .057) (1.2) ( 1 - .35) Therefore RU = .11234 I,e 11.23%

(c)

To find the cost of equity under different capital structure we can again use the wacc equation with a debt equity ratio of 2, the cost of equity is: .09 = ( 1/3) RE + (2/3)( .057)(1-.35)

RE = .198 I , e 19.81

(d)

with a debt equity ratio of 1, the cost of equity is: .09 = (1/2)RE + (1/2) (.057)(1-.35) RE = 14.3 % And with a debt equity ratio of 0, the cost of equity is: .09 = (1)RE +( 0) (.057)(1-.35) RE = 9%

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