Shadow Corp. has no debt but can borrow at 7.5 percent. The firm’s WACC is curre

Question

Shadow Corp. has no debt but can borrow at 7.5 percent. The firm’s WACC is currently 9.3 percent, and the tax rate is 35 percent.
  
a. What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  

b. If the company converts to 15 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

c. If the company converts to 60 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

d-1. If the company converts to 15 percent debt, what will the company's WACC be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
d-2. If the company converts to 60 percent debt, what will the company's WACC be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

WACC = Wd×Rd+We×Ke

W is weights of respective portfolios

R is return on respective portfolios

Wd+We = 1

Ke = (WACC-Wd×Rd)÷We

a)

Ke = 9.3%

b)

Ke = (9.3%-0.15×4.875%)÷0.85

= 10.08%

c)

Ke = (9.3%-0.60×4.875%)÷0.40

= 15.94%

d-1)

WACC = Wd×Rd+We×Ke

W is weights of respective portfolios

R is return on respective portfolios

Wd+We = 1

15% debt:

d-2)

WACC = Wd×Rd+We×Ke

= 0.15×4.875%+0.85×10.08%

= 9.30%

60% debt:

WACC = Wd×Rd+We×Ke

= 0.60×4.875%+0.40×10.08%

= 6.96%

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