Question

PLEASE SHOW WORKING AND FORMULA STEP BY STEP. DO NOT USE EXCEL

Blitz Industries has a debt-equity ratio of .6. Its WACC is 9.2 percent, and its cost of debt is 6.5 percent. The corporate tax rate is 23 percent.

  

a.	What is the company’s cost of equity capital?
b.	What is the company’s unlevered cost of equity capital?
c-1.	What would the cost of equity be if the debt-equity ratio were 2?
c-2.	What would the cost of equity be if the debt-equity ratio were 1.0? (
c-3.	What would the cost of equity be if the debt-equity ratio were zero?

Answer 1

D/A = D/(E+D)

D/A = 0.6/(1+0.6)

=0.375

E/A = 1-D/A

=1-0.375

=0.625

a

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

0.092= Levered cost of equity*=0.625+0.065*(1-0.23)*=0.375

Levered cost of equity =11.72%

b

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

0.11717 = Unlevered cost of equity+0.6*(Unlevered cost of equity-0.065)*(1-0.23)

Unlevered cost of equity = 10.07

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 = 10.07+2*(10.07-0.065)*(1-0.23)

Levered cost of equity = 25.48

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 = 10.07+1*(10.07-0.065)*(1-0.23)

Levered cost of equity = 17.77

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 = 10.07+0*(10.07-0.065)*(1-0.23)

Levered cost of equity = 10.07