Question

Dickson, Inc., has a debt-equity ratio of 2.5. The firm’s weighted average cost of capital is 11 percent and its pretax cost of debt is 9 percent. The tax rate is 22 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.	What would the company’s weighted average cost of capital be if the company's debt-equity ratio were .60 and 1.50? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

D/A = D/(E+D)

D/A = 2.5/(1+2.5)

=0.7143

E/A = 1-D/A

=1-0.7143

=0.2857

a

WACC = Levered cost of equity*E/A+Cost of debt*(1-tax rate)*D/A

0.11= Levered cost of equity*0.2857+0.09*(1-0.22)*0.7143

Levered cost of equity =20.95%

b

Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate)

0.2095 = Unlevered cost of equity+2.5*(Unlevered cost of equity-0.09)*(1-0.22)

Unlevered cost of equity = 13.05

C-1

Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate)

Levered cost of equity = 13.05+0.6*(13.05-9)*(1-0.22)

Levered cost of equity = 14.95

C-2

Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate)

Levered cost of equity = 13.05+1.5*(13.05-9)*(1-0.22)

Levered cost of equity = 17.79