Assume that XYZ Corporation is a leveraged company with the following information: Kl = cost of...

Assume that XYZ Corporation is a leveraged company with the following information: Kl = cost of equity capital for XYZ = 13 percent i = before-tax borrowing cost = 8 percent t = marginal corporate income tax rate = 30 percent Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted average cost of capital of 9.3 percent and 13 percent respectively

Solutions

Expert Solution

Given:-

Cost of equity (Ke)= 13%,

Cost of Debt (Kd) (after tax) = 8 * (1-.3) = 5.6%

Solution: Calculation of Debt to total market value

Case 1: when WACC is 9.3%

NOTE: weight of equity + weight of debt =1

therefore, weight of debt = 1 - weight of equity

WACC = (Ke * weight of equity ) + [ kd after tax * (1 -weight of equity) ]

9.3 = (13 * weight of equity) + [ 5.6 * (1-weight of equity) ]

weight of equity = 0.50

weight of debt = 1- weight of equity = 1 - 0.50

weight of debt = 0.50

Thus "Debt to market value ratio" that will result in WACC of 9.3% is 0.50 times or 50%

Case 1: when WACC is 13%

NOTE: weight of equity + weight of debt =1

therefore, weight of debt = 1 - weight of equity

WACC = (Ke * weight of equity ) + [ kd after tax * (1 -weight of equity) ]

13 = (13 * weight of equity) + [ 5.6 * (1-weight of equity) ]

weight of equity = 1

weight of debt = 1- weight of equity = 1 - 1

weight of debt = 0

Thus "Debt to market value ratio" that will result in WACC of 13% is 0 times or 0%

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