Williamson, Inc., has a debt–equity ratio of 2.42. The firm’s weighted average c

Question

Williamson, Inc., has a debt–equity ratio of 2.42. The firm’s weighted average cost of capital is 10 percent, and its pretax cost of debt is 6 percent. Williamson is subject to a corporate tax rate of 35 percent.

What is Williamson’s unlevered cost of equity capital? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

What would Williamson’s weighted average cost of capital be if the firm’s debt–equity ratio were .70 and 1.85? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

Part a and b are correct but I cannot figure out part c- thank you.

Williamson, Inc., has a debt–equity ratio of 2.42. The firm’s weighted average cost of capital is 10 percent, and its pretax cost of debt is 6 percent. Williamson is subject to a corporate tax rate of 35 percent.

Explanation / Answer

C.

Debt Equity ratio = 0.70.

Levered cost of Equity = 0.1328 + 0.70(0.1328-0.06)*(1-0.35) = 0.1659 or 16.59%.

Weighted average cost of capital = (0.70/1.70)*0.06(1-0.35) +(1/1.70)(0.1659) = 0.113647 or 11.365%.

Debt Equity ratio = 1.85.

Levered cost of Equity = 0.1328 + 1.85(0.1328-0.06)*(1-0.35) = 0.22034 or 22.03%.

Weighted average cost of capital = (1.85/2.85)*0.06(1-0.35) +(1/2.85)(0.22034) = 0.102628 or 10.263%.

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