Question

Blitz Industries has a debt-equity ratio of 1.4. Its WACC is 8.4 percent, and its cost of debt is 6.1 percent. The corporate tax rate is 21 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-1.	What would the cost of equity be if the debt-equity ratio were 2? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c-2.	What would the cost of equity be if the debt-equity ratio were 1.0? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c-3.	What would the cost of equity be if the debt-equity ratio were zero? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

a

D/A = D/(E+D)

D/A = 1.4/(1+1.4)

=0.5833

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 6.1*(1-0.21)

= 4.819

Weight of equity = 1-D/A

Weight of equity = 1-0.5833

W(E)=0.4167

Cost of Capital = Weight of Equity*Cost of Equity+Weight of Debt*Cost of Debt

8.4 = Cost of Equity*0.4167+4.819*0.5833

Cost of Equity = 13.41

b

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

13.4127 = Unlevered cost of equity+1.4*(Unlevered cost of equity-6.1)*(1-0.21)

Unlevered cost of equity = 9.57

c1

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

Levered cost of equity = 9.57232+2*(9.57232-6.1)*(1-0.21)

Levered cost of equity = 15.06

c2

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

Levered cost of equity = 9.57232+1*(9.57232-6.1)*(1-0.21)

Levered cost of equity = 12.32

c3

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

Levered cost of equity = 9.57232+0*(9.57232-6.1)*(1-0.21)

Levered cost of equity = 9.57