ONLY Part B AND C needed Williamson, Inc., has a debt-equity ratio of 2.51. The

Question

ONLY Part B AND C needed

Williamson, Inc., has a debt-equity ratio of 2.51. The company's weighted average cost of capital is 9 percent, and its pretax cost of debt is 7 percent. The corporate tax rate is 40 percent. What is the company's cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) What is the company's unlevered cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) What would the company's weighted average cost of capital be if the company's debt-equity ratio were.70 and 1.55? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

part A)

After tax cost of debt = 7% x (1-0.40)

                                           = 4.20%

Weight of debt = 2.51/ (1+2.51) = 0.7151

Weight of equity = 1-0.7151 = 0.2849

WACC = We x Re + Wd x Kd

0.09 = 0.2849x Re + 0.7151 x 0.0420

Re = (0.09-0.03003)/ 0.2849

Re = 21.05%

Part B

Re = Ru + D/E x (Ru-Rd)

0.2105 = Ru + 2.51 x(Ru – 0.042)

3.51 Ru = 0.31592

Ru = 9%

Part c)

D/E= 0.70

Wd = 0.70 / (1+0.70) = 0.4118

We = 1-0.4118 = 0.5882

Re = Ru + D/E x (Ru-Rd)

      = 0.09 + 0.70 x (0.09-0.042)

     = 12.36%

WACC = We x Re + Wd x Kd

             = 0.5882 x 0.1236 + 0.4118 x0.042

              = 9%

We can see that WACC is constant irrespective of changes in weights and D/E ratio. Therefore WACC will remain 9% even at 1.55 D/E ratio.

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