Kunitz Co. has no debt. Its cost of capital is 9.7 percent. Suppose Kunitz conve

Question

Kunitz Co. has no debt. Its cost of capital is 9.7 percent. Suppose Kunitz converts to a debt-equity ratio of 1. The interest rate on the debt is 6.8 percent. Ignore taxes for this problem.

What is the company’s new cost of equity? (Do not round intermediate calculations. Enter youd answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What is its new WACC? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Kunitz Co. has no debt. Its cost of capital is 9.7 percent. Suppose Kunitz converts to a debt-equity ratio of 1. The interest rate on the debt is 6.8 percent. Ignore taxes for this problem.

Explanation / Answer

Cost of Equity:

When the company is all-equity financed, the cost of equity is:

WACC = Re= 0.097 or 9.7%

Re= Ra+ (Ra– Rd)(D/E)

RE = 0.097 + (0.097 – 0.068)(1)

RE = 0.126 or 12.6%

And the new WACC will be:

WACC = (E/V)RE+ (D/V)Rd

WACC = (.50)0.126 + (.50)(0.068)

WACC = 0.097 or 9.7%

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