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Cost of Capital Harris, Inc., has equity with a market value of $18.5 million and debt...

Cost of Capital
Harris, Inc., has equity with a market value of $18.5 million and debt with a market value of $7.3 million. Treasury bills that mature in one year yield 4 percent per year and the expected return on the market portfolio is 11 percent. The beta of the company's equity is 1.15. The firm pays no taxes.

a. What is the company's debt-equity ratio?
b. What is the firm's weighted average cost of capital?
c. What is the cost of capital for an otherwise identical all-equity firm?

Show all the steps and don't round off calculations.

Expert Solution

a.

The market value of equity is $18.5 million and the market value of debt is $7.3 million.

The debt-equity ratio is calculated below:

The debt-equity ratio is 0.39.

b.

The cost of debt is already given, but the cost of equity needs to be calculated.

The below expression can be used to calculate the cost of equity:

It is mentioned in the question that the firm pays no taxes.

The weighted average cost of capital is calculated below:

The WACC is 0.098 or 9.8%.

c.

The cost of equity capital for an otherwise identical all-equity firm is same as WACC before tax.

The cost of capital is calculated below:

The cost of capital is 9.8%.

jeff jeffy answered 6 months ago

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