Skillet Industries has a debt–equity ratio of 1.6. Its WACC is 8.6 percent, and

Question

Skillet Industries has a debt–equity ratio of 1.6. Its WACC is 8.6 percent, and its cost of debt is 6.1 percent. The corporate tax rate is 35 percent.

What is the company’s cost of equity capital? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the company’s unlevered cost of equity capital? (Round your answer to 2 decimal places. (e.g., 32.16))

What would the cost of equity be if the debt–equity ratio were 2? (Round your answer to 2 decimal places. (e.g., 32.16))

What would the cost of equity be if the debt–equity ratio were 1.0? (Round your answer to 2 decimal places. (e.g., 32.16))

What would the cost of equity be if the debt–equity ratio were zero? (Round your answer to 2 decimal places. (e.g., 32.16))

Skillet Industries has a debt–equity ratio of 1.6. Its WACC is 8.6 percent, and its cost of debt is 6.1 percent. The corporate tax rate is 35 percent.

Explanation / Answer

Debt / Equity = 1.6

1.6 Equity = Debt

Debt + Equity = 1

1.6 Equity + Equity = 1

2.6 Equity = 1

Equity = 1/2.6 i.e 0.3846

Debt = 1-0.3846 i.e 0.6154

WACC = Weight of debt * Cost of debt + Weight of Equity * Cost of Equity

8.6 = 0.6154*3.965+0.3846*x

8.6-2.44=3.846x

X = 16% cost of equity = 16%

B) Unlevered cost of equity capital = Weighted average cost of capital

= 8.6%

C) Cost of equity if debt equity ratio is 2

Debt / Equity = 2

2 Equity = debt

Debt + Equity = 1

2 Equity + Equity = 1

3 Equity = 1

Equity = 1/3 i.e 0.33

Debt = 0.67

WACC = Weight of debt * cost of debt+ Weight of equity * Cost of equity

8.6 = 0.67*3.965+0.33*X

8.6-2.66 = 0.33X

X = 18%

D) Cost of equity when debt equity ratio = 1

8.60 = 0.50*3.965 +0.50X

X = 13.235%

E) Cost of equity when debt equity ratio = 0

Cost of equity = 0

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