Question

Blitz Industries has a debt-equity ratio of 1.25. Its WACC is 8.3 percent, and its cost of debt is 5.1 percent. The corporate tax rate is 21 percent.

  

a.	What is the company’s cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	What is the company’s unlevered cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c-1.	What would the cost of equity be if the debt-equity ratio were 2? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c-2.	What would the cost of equity be if the debt-equity ratio were 1? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c-3.	What would the cost of equity be if the debt-equity ratio were zero? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

a) WACC =Weight of Equity*Cost of Equity+Weight of Debt*Cost of Debt*(1-Tax Rate)
8.3%=1/2.25*Cost of Equity Capital+1.25/2.25*5.1%*(1-21%)
(8.3%-1.25/2.25*5.1%*(1-21%))*2.25 =Cost of Equity Capital
Cost of Equity Capital=13.64%

b) Cost of Levered Equity Capital=Cost of Unlevered Equity Capital+Debt*(1-Tax Rate)/Equity*(Cost of Unlevered Equity Capital-Cost of Debt)
13.6388% =Cost of Unlevered Equity Capital+1.25*(1-21%)*(Cost of Unlevered Equity Capital-5.1%)
Cost of unlevered equity *(1+1.25*0.79)=13.6388%+1.25*0.79*5.1%
Cost of Unlevered Equity =9.40% or 9.3963%

c-1)Cost of Levered Equity Capital=Cost of Unlevered Equity Capital+Debt*(1-Tax Rate)/Equity*(Cost of Unlevered Equity Capital-Cost of Debt) =9.3963%+2*(1-21%)*(9.3963%-5.1%) =16.18%

d)Cost of Levered Equity Capital=Cost of Unlevered Equity Capital+Debt*(1-Tax Rate)/Equity*(Cost of Unlevered Equity Capital-Cost of Debt) =9.3963%+1*(1-21%)*(9.3963%-5.1%) =12.79%

d) Cost of Levered Equity Capital=Cost of Unlevered Equity Capital+Debt*(1-Tax Rate)/Equity*(Cost of Unlevered Equity Capital-Cost of Debt) =9.3963%+0*(1-21%)*(9.3963%-5.1%) =9.40%


​​​​​