Question

Unlevered Cost of Equity

Elliott's Cross Country Transportation Services has a capital structure with 30% debt at an 8% interest rate. Its beta is 1.5, the risk-free rate is 4%, and the market risk premium is 9%. Elliott's combined federal-plus-state tax rate is 25%.

1. What is Elliott's cost of equity? Do not round intermediate calculations. Round your answer to two decimal places.

     %_____

2. What is its weighted average cost of capital? Do not round intermediate calculations. Round your answer to two decimal places.

     %______

3. What is its unlevered cost of equity? Do not round intermediate calculations. Round your answer to two decimal places.

     %______

Answer 1

a.
Cost of equity = Risk free + Market risk premium * Beta = 4% + 9% * 1.5	17.50%
b.
Weighted average cost of capital = Cost of equity * Equity % + Cost of debt * ( 1 - Tax%) * Debt % = 17.50% * 70% + 8%*(1-25%)*30%	14.05%
c.
Levered Cost of equity = Unlevered cost of equity + ( Unlevered cost of equity - Cost of debt ) * ( 1 -Tax%) * Debt/Equity
17.50% = Unlevered cost of equity + ( Unlevered cost of equity - 8% ) * (1-25%) * 0.3/0.7
17.50% = Unlevered cost of equity + ( Unlevered cost of equity - 8% ) * (1-25%) * 0.3/0.7
17.50% = Unlevered cost of equity + ( Unlevered cost of equity - 8% ) * 0.225/0.7
17.50% = Unlevered cost of equity + 0.225/0.7*Unlevered cost of equity - 0.018/0.7
( 17.50% + 0.018/0.7 ) = Unlevered cost of equity + 0.225/0.7*Unlevered cost of equity
( 17.50% + 0.018/0.7 ) = (0.7+0.225)/0.7 *Unlevered cost of equity
Unlevered cost of equity = ( 17.50% + 0.018/0.7 ) / ( (0.7+0.225)/0.7 )	15.19%