16- Twice Shy Industries has a debtequity ratio of 1.8. Its WACC is 8.3 percent,

Question

16-

Twice Shy Industries has a debtequity ratio of 1.8. Its WACC is 8.3 percent, and its cost of debt is 6.3 percent. The corporate tax rate is 35 percent.

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

What would the cost of equity be if the debtequity ratio were 2? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

What would the cost of equity be if the debtequity ratio were 1.0? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

What would the cost of equity be if the debtequity ratio were zero? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Twice Shy Industries has a debtequity ratio of 1.8. Its WACC is 8.3 percent, and its cost of debt is 6.3 percent. The corporate tax rate is 35 percent.

Explanation / Answer

Answer a Debt equity ratio = 1.8 It means Debt = 1.8 and Equity = 1 Weight for Debt = 1.8 / 2.8 = 0.64 and Weight for Equity = 1/2.8 = 0.36 WACC = (Weight for debt* after tax cost of debt) + (Weight for equity * cost of equity) After tax cost of debt = cost of debt * (1-tax rate) = 6.3% * (1-0.35) = 0.04095 0.083 = (0.64* 0.04095) + (0.36 * cost of equity) 0.36 * cost of equity = 0.083 - 0.026325 Cost of equity = 0.1574 i.e.15.74% Answer b Unlevered cost of equity capital i.e.Cost of equity capital when there is zero debt = 8.3% Answer c-1 Debt equity ratio = 2 It means Debt = 2 and Equity = 1 Weight for Debt = 2 / 3 = 0.67 and Weight for Equity = 1/3 = 0.33 WACC = (Weight for debt* after tax cost of debt) + (Weight for equity * cost of equity) After tax cost of debt = cost of debt * (1-tax rate) = 6.3% * (1-0.35) = 0.04095 0.083 = (0.67* 0.04095) + (0.33 * cost of equity) 0.33 * cost of equity = 0.083 - 0.02730 Cost of equity = 0.1688 i.e.16.88% Answer c-2 Debt equity ratio = 1 It means Debt = 1 and Equity = 1 Weight for Debt = 1 / 2 = 0.50 and Weight for Equity = 1/2 = 0.50 WACC = (Weight for debt* after tax cost of debt) + (Weight for equity * cost of equity) After tax cost of debt = cost of debt * (1-tax rate) = 6.3% * (1-0.35) = 0.04095 0.083 = (0.50* 0.04095) + (0.50 * cost of equity) 0.50 * cost of equity = 0.083 - 0.020475 Cost of equity = 0.1251 i.e.12.51% Answer c-3 Debt equity ratio = 0 It means Debt = 0 and Equity = 1 Weight for Debt = 0 / 1 = 0 and Weight for Equity = 1/1 = 1 WACC = (Weight for debt* after tax cost of debt) + (Weight for equity * cost of equity) After tax cost of debt = cost of debt * (1-tax rate) = 6.3% * (1-0.35) = 0.04095 0.083 = (0* 0.04095) + (1 * cost of equity) Cost of equity = 8.3%

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