In: Finance
Citee Corp. has no debt but can borrow at 6.4 percent. The firm’s WACC is currently 9.7 percent, and the tax rate is 22 percent. |
a. |
What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
b. | If the firm converts to 25 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
c. | If the firm converts to 50 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
d-1. | If the firm converts to 25 percent debt, what is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
d-2. | If the firm converts to 50 percent debt, what is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
a
Company has no debt hence cost of equity = WACC = 9.7%
b
D/A = 0.25
D/E = D/(A-D) = 0.25/(1-0.25)=0.3333
Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate) |
Levered cost of equity = 9.7+0.3333*(9.7-6.4)*(1-0.22) |
Levered cost of equity = 10.56 |
c
D/A = 0.5
D/E = D/(A-D) = 0.5/(1-0.5)=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 = 9.7+1*(9.7-6.4)*(1-0.22) |
Levered cost of equity = 12.27 |
d1
After tax cost of debt = cost of debt*(1-tax rate) |
After tax cost of debt = 6.4*(1-0.22) |
= 4.992 |
Weight of equity = 1-D/A |
Weight of equity = 1-0.25 |
W(E)=0.75 |
Weight of debt = D/A |
Weight of debt = 0.25 |
W(D)=0.25 |
WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
WACC=4.99*0.25+10.56*0.75 |
WACC% = 9.17 |
d2
After tax cost of debt = cost of debt*(1-tax rate) |
After tax cost of debt = 6.4*(1-0.22) |
= 4.992 |
Weight of equity = 1-D/A |
Weight of equity = 1-0.5 |
W(E)=0.5 |
Weight of debt = D/A |
Weight of debt = 0.5 |
W(D)=0.5 |
WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
WACC=4.99*0.5+12.27*0.5 |
WACC% = 8.63 |