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tatic/nb/uiindex.html?nbld-607674&nbNodeld; 222524532elSBN 97813056359758!8parentld-222525022 Find on page ! will be 10%, and it will face a tax rate of 35% ×| ! No results Options-v MINDTAP Assignment 13-Capital Structure and Leverage 0 Due on Nov 15 at 11.59 PM CST Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (r) is 4%, and the market risk premium (RP) is 7%. Blue Ram's marginal tax rate is30%. Blue Ram is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table Before-Tax Bond Cost of Debt Levered Cost of D/A E/A Ratio Ratio D/E Ratio Rating (ra) Beta (b) 1.2 0.0 1.0 0.2 0.8 0.4 0.6 0.6 0.4 0.8 0.2 0.00 0.25 0.67 1.50 Equity (rs) 12.40% 13.87% 16.32% WACC 12.40% 12.27% 8.4% 8.9% 1.76 2.46 4.56 13.15% 14.3% 35.92% Grade R Now Type here to search

Explanation / Answer

cost of equity=risk fre+beta*(market-risk free)=risk free+beta*(market risk premium)

WACC=D/A*before tax cost of debt*(1-tax rate)+E/A*cost of equity

1

D/A=0.2, cost of equity=13.87%

Hence, 13.87%=4%+beta*7%

So, beta=1.41

2

D/A=0.4, E/A=0.6 Tax rate=30%..hence, WACC=0.4*8.9%*(1-30%)+0.6*16.32%=12.284%

3

D/A=0.6, E/A=0.4 Tax rate=30%..hence, WACC=0.6*11.1%*(1-30%)+0.4*cost of equity

=>13.15%=0.6*11.1%*(1-30%)+0.4*cost of equity

So, cost of equity=21.22%

4

D/A=0.8

E/A=0.2

D/E=0.8/0.2=4

D/A=0.8, E/A=0.2 Tax rate=30%..hence, WACC=0.8*14.3%*(1-30%)+0.2*35.92%

So, WACC=15.192%

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