Twice Shy Industries has a debt-equity ratio of 1.3. Its WACC is 6 percent, and

Question

Twice Shy Industries has a debt-equity ratio of 1.3. Its WACC is 6 percent, and its cost of debt is 5.8 percent. The corporate tax rate is 35 percent a. 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.) Cost of equity capital Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Unlevered cost of equity capital b. What is the company's unlevered cost of equity capital? (Do not round intermediate calculations. c-1 What would the cost of equity be if the debt-equity ratio were 2? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity c-2 What would the cost of equity be if the debt-equity ratio were 1.0? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity c-3 What would the cost of equity be if the debt-equity ratio were zero? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity

Explanation / Answer

Given the following:-

D/E Ratio = 1.30, WACC = 6%, cost of debt(Kd) = 5.80 %, tax rate = 35 % Post tax Kd = 5.80*0.65 = 3.77%

a. WACC = Wd*Kd  (+) We*Ke

Wd =1.30/2.30,  We = 1/2.30

6 = 1.30/2.30 * 3.77 (+) 1/2.30*Ke

By solving the above Ke(Cost of equity) = 8.90 %

b. Companys Unlevered cost of equity means that the company uses no debt.

So WACC is 6.00. so if we eliminate the debt from this than we can get the unlevered cost of equity which will be 6.48 % {(6/1.30/2.30) * (3.77)}*2.30= 6.48 %.

c1. D/E Ratio = 2.00 then  Wd =2/3,  We = 1/3, By applying the same method as in (a) Ke = 10.46 %

c2. D/E Ratio = 1.00 then  Wd =1/2,  We = 1/2, By applying the same method as in (a) Ke = 8.23 %

c3. If D/E ratio is NIL means that it is a no debt company so WACC = Cost of equity which is 6%

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