Question

TheTiole company has a debt-equity ratio f 1.1. its cost of debt is 5.1 percent, and the applicable corporate tax rate is 21 percent resulting in a WACC of 7.3 percent and a firms asset beta of one;

What is the company's cost of equity?

What is the company's unlevered cost of equity?

What would the cost of equity be if the debt-equity ratio were 2x?

Find the beta for this firm for the debt-equity ratios of 0 and 1.1x.

Answer 1

1]	WACC = After tax cost of debt*Weight of debt+Cost of equity*Weight of equity
	After tax cost of debt = 5.1%*(1-21%) =	4.03%
	Substituting available values, we have
	0.073 = 0.0403*1.1/2.1+Cost of equity*1/2.1
	Solving for cost of equity
	Cost of equity = (0.073-0.0403*1.1/2.1)*2.1/1 =	10.90%
2]	We have levered cost of equity = Unlevered cost of equity+(Unlevered cost of equity-Cost of debt)*(1-t)*D/E
	So,
	0.10897 = Unlevered cost of equity+(Unlevered cost of equity-0.051)*1.1*0.79
	0.10897 = Unlevered cost of equity+0.869*Unlevered cost of equity-0.044319
	0.153289 = 1.869*Unlevered cost of equity
	Unlevered cost of equity = 0.153289/1.869 =	8.20%
3)	Cost of equity = 0.082+(0.082-0.051)*0.79*2 = =	13.10%
4]	Beta for debt equity ratio of 0 =	1.00
	Beta for debt equity ratio of 1.1 = 1*(1+0.79*1.1) =	1.87
	Formula for levering of beta is:
	Levered beta = Unlevered beta*[1+(1-t)*D/E]