Question

Skillet Industries has a debt–equity ratio of 1.3. Its WACC is 8.6 percent, and its cost of debt is 7.4 percent. The corporate tax rate is 35 percent.

  

a.	What is the company’s cost of equity capital? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Cost of equity capital

%

b.	What is the company’s unlevered cost of equity capital? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Unlevered cost of equity capital

%

  

c-1	What would the cost of equity be if the debt–equity ratio were 2? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Cost of equity

%

  

c-2	What would the cost of equity be if the debt–equity ratio were 1.0? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Cost of equity

%

  

c-3	What would the cost of equity be if the debt–equity ratio were zero? (Round your answer to 2 decimal places. (e.g., 32.16))

Answer 1

D/A = D/(E+D)

D/A = 1.3/(1+1.3)

=0.5652

E/A = 1-D/A

=1-0.5652

=0.4348

a

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

0.086= Levered cost of equity*0.4348+0.074*(1-0.35)*0.5652

Levered cost of equity =13.53%

b

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

0.13527 = Unlevered cost of equity+1.3*(Unlevered cost of equity-0.074)*(1-0.35)

Unlevered cost of equity = 10.72

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 = 10.72+2*(10.72-7.4)*(1-0.35)

Levered cost of equity = 15.04

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 = 10.72+1*(10.72-7.4)*(1-0.35)

Levered cost of equity = 12.88

C-3

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

Levered cost of equity = 10.72+0*(10.72-0.074)*(1-0.35)

Levered cost of equity = 10.72