Advanced Corporate c eGChegg Study! Guided xYolchegg.co × ica/Documents/Addl%20L

Question

Advanced Corporate c eGChegg Study! Guided xYolchegg.co × ica/Documents/Addl%20Leverage%20&%20Cap%20Structure%20Problems.pdf 3. Leverage and the cost of capital Gaucho Services starts life with all-equity financing and a cost of equity of 14%. Suppose it refinances to the following market-value capital structure: Debtco, Equity 45% 55% at'o=0.5% Use MM's proposition 2 to calculate the new cost of equity. Gaucho pays taxes at a marginal rate of Tc-40%. Calculate Gaucho's after-tax weighted-average cost of capital

Explanation / Answer

Re = R0 + (D/E)*(R0 - Rd)*(1-tax rate)

Re = 14% + (45%/55%)*(14% - 9.5%)*(1-40%) = 16.21%

WACC = 45%*9.5%*(1-40%) + 55%*16.21% = 11.48%

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