The answers are NOT: B) 10.20 or 9.77 C) 12.04 or 11.14 D-1) 8.71 or 7.37 D-2) 8
ID: 2776993 • Letter: T
Question
The answers are NOT:
B) 10.20 or 9.77
C) 12.04 or 11.14
D-1) 8.71 or 7.37
D-2) 8.92 or 6.76
Shadow Corp. has no debt but can borrow at 6.6 percent. The firm's WACC is currently 8.4 percent, and the tax rate is 35 percent. What is Shadow's cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).) If the firm converts to 25 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as a percent rounded 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. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).) If the firm converts to 25 percent debt, what will the company's WACC be? (Do not round intermediate calculations. Enter your answer as a percent rounded 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. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)Explanation / Answer
a. For an all-equity financed company:
WACC = RU = RE = 8.4%
b. To find the cost of equity for the company with leverage we need to use M&M Proposition II with taxes, so:
RE = RU + (RU - RD)(D/E)(1 - T)
RE =0.084+(0.084-0.066)*(0.25/0.75)*0.65
RE = 8.79%
c. Using M&M Proposition II with taxes again, we get:
RE = RU + (RU - RD)(D/E)(1 - T)
RE =0.084+(0.084-0.066)*(0.4/0.6)*0.65
RE = 9.18%
d. The WACC with 25 percent debt is:
WACC = (E/V)RE + (D/V)RD(1 - T)
WACC = .75*(.0879) + .25*(.066)*(1 - .35)
WACC = 7.67%
And the WACC with 40 percent debt is:
WACC = (E/V)RE + (D/V)RD(1 - T)
WACC = .60*(.0918) + .40*(.066)*(1 - .35)
WACC = 7.22%
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