Weston Industries has a debt–equity ratio of 1.3. Its WACC is 8.6 percent, and i

Question

Weston Industries has a debt–equity ratio of 1.3. Its WACC is 8.6 percent, and its cost of debt is 7.4 percent. The corporate tax rate is 35 percent.

a. What is Weston'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 13.53 b. What is Weston'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 debt-equity 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 debt-equity ratio were 1? (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 debt-equity 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

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)

0.1353 = RU + (RU – 0.074)(1.3)(1 – 0.35)

0.1353 = RU + 0.845RU - 0.0625

1.845 RU = 0.1978

RU = 0.1072 OR 10.72%

C-1

WACC = (E/V)RE + (D/V)RD(1 – TC)

0.086 = (1/3)RE + (2/3)(0.074)(1 – 0.35)   

0.086 = (1/3)RE + 0.0321

(1/3)RE = 0.0539

RE = 0.1797 OR 17.97%

C-2

WACC = (E/V)RE + (D/V)RD(1 – TC)

0.086 = (1/2)RE + (1/2)(0.074)(1 – 0.35)   

0.086 = (1/2)RE + 0.02405

(1/2)RE = 0.06195

RE = 0.1239 OR 12.39%

C-3

WACC = (E/V)RE + (D/V)RD(1 – TC)

0.086 = (1)RE + (0)(0.074)(1 – 0.35)      

0.086 = (1)RE + 0

RE = 0.086 OR 8.6%

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