Question

elliott's cross country transportation services has a capital structure with 25% debt at a 9% interest rate. Its beta is 1.6 , the risk-free rate is 4%, and the market risk preimum is 7%. Elliott's combined federal-plus-state tax rate is 25%

What is the cost of equity ?

What is the WAAC?

What is its unlevered cost of equity?

Answer 1

Answer of Part a:

Cost of Equity = Risk free Rate + Beta * Market Risk Premium
Cost of Equity = 0.04 + 1.6 * 0.07
Cost of Equity = 0.04 + 0.112
Cost of Equity = 0.152 or 15.2%

Answer of Part b:

WACC = Weight of Debt * Cost of Debt * (1-tax rate) + Weight of Equity * Cost of Equity
WACC = 0.25 * 0.09 * (1 – 0.25) + 0.75 * 0.152
WACC = 0.25 * 0.0675 + 0.114
WACC = 0.0169 + 0.114
WACC = 0.1309 or 13.09%

Answer of Part c:

Debt-Equity Ratio = Weight of Debt / Weight of Equity
Debt-Equity Ratio = 0.25 / 0.75
Debt-Equity Ratio = 1/3

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - tax) * Debt-Equity Ratio
0.1520 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.09) * (1 - 0.25) * (1/3)
0.1520 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.09) * 0.25
0.1520 = Unlevered Cost of Equity + 0.25 * Unlevered Cost of Equity - 0.0225
0.1745 = 1.25 * Unlevered Cost of Equity
Unlevered Cost of Equity = 0.1396 or 13.96%