Shadow Corp. has no debt but can borrow at 6.9 percent. The firm’s WACC is curre

Question

Shadow Corp. has no debt but can borrow at 6.9 percent. The firm’s WACC is currently 8.7 percent, and the tax rate is 35 percent.

What is Shadow’s cost of equity? (Do not round intermediate calculations.)

If the firm converts to 35 percent debt, what will its cost of equity be? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

If the firm converts to 40 percent debt, what will its cost of equity be? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

If the firm converts to 35 percent debt, what will the company's WACC be? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

If the firm converts to 40 percent debt, what will the company's WACC be? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

What is Shadow’s cost of equity? (Do not round intermediate calculations.)

Explanation / Answer

a. Since shadows capital structure does not contain debt therefore its WACC will be its cost of equity. Thus cost of equity of shadow will be 8.70%

b. Cost of debt = 6.90(1-0.35)

= 4.485%

WACC = KexWe + KdxWd

8.70 = Kex0.65 + 4.485x0.35

Ke = 10.97%

c. 8.70 = Kex0.60 + 4.485x0.40

Ke = 11.51%

d (1). Current cost of equity = 8.70%

Cost of debt = 4.485%

WACC = 8.70x0.65 + 4.485x0.35

= 7.22%

(2) WACC = 8.70x0.60 + 4.485x0.40

= 7.01%

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