3. Shadow Corp. has no debt but can borrow at 8 percent. The firm’s WACC is curr
ID: 2782117 • Letter: 3
Question
3.
Shadow Corp. has no debt but can borrow at 8 percent. The firm’s WACC is currently 9.8 percent, and the tax rate is 35 percent.
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.)
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.)
If the company converts to 50 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.)
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.)
If the company converts to 50 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.)
WACC
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3.
Shadow Corp. has no debt but can borrow at 8 percent. The firm’s WACC is currently 9.8 percent, and the tax rate is 35 percent.
Explanation / Answer
Answer a) For an all-equity financed company: WACC = R0 = Rs = .098, or 9.8%
Answer b) Rs = R0 + ( R0 – R B )( B / S )(1 – T C )
R S = .098 + (.098 – .080)(0.15 / 0.85)(1 – 0.35)
R S = .1001, or 10.01%
Answer c) Rs = R0 + ( R0 – R B )(B /S )(1 –T C )
Rs = .098 + (.098 – .080)(.50 / .50)(1 – .35)
Rs = .1097, or 10.97%
Answer d)
The WACC with 15 percent debt is: WACC = ( S / V ) R S + (( B / V ) R B (1 – T C )
WACC = .85(.1001) + .15(.080)(1 – .35)
WACC = .0929, or 9.29%
And the WACC with 50 percent debt is:
WACC = ( S / V ) R S + ( B / V ) R B (1 – T C )
WACC = .50(.1097) + .50(.080)(1 – .35)
WACC = .0809, or 8.09%
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