Weston Industries has a debt–equity ratio of 1.8. Its WACC is 8.3 percent, and i

Question

Weston Industries has a debt–equity ratio of 1.8. Its WACC is 8.3 percent, and its cost of debt is 6.3 percent. The corporate tax rate is 35 percent.

A) What is Weston's cost of equity capital? (Do not round intermediate calcuations. Round answer to 2 decimal places)

B) What is Weston's unlevered cost of equity capital? (Do not round intermediate calcuations. Round answer to 2 decimal places)

C) What would the cost of equity be if the debt-equity ratio were 2? (Do not round intermediate calcuations. Round answer to 2 decimal places)

D) What would the cost of equity be if the debt-equity ratio were 1? (Do not round intermediate calcuations. Round answer to 2 decimal places)

E) What would the cost of equity be if the debt-equity ratio were 0? (Do not round intermediate calcuations. Round answer to 2 decimal places)

Explanation / Answer

Let's assume that weight of debt in capital is W, so weight of equity in capital will be 1-W

1.8 = W/(1-W)
1.8 - 1.8W = W
W = 1.8/2.8 = 0.6428 or 64.28%, which is weight of debt in the capital.
Equity in capital = 1 -0.6428 = 0.3572 or 35.72%

a) WACC = (wd x rd) + (we x ke)
=> 0.083 = (0.6428 x 0.063) + (0.3572 x ke)
=> ke = (0.083 - 0.040490)/0.3572 = 0.1190 or 11.90%

b) To answer this part, we need beta of the firm. Please provide.

c) Debt-Equity ratio of 2 means that weight of debt in the capital is 66.67% (2/3) and weight of equity is 33.33% (1/3)
WACC = (wd x rd) + (we x ke)
=> 0.083 = (0.6667 x 0.063) + (0.3333 x ke)
=> ke = (0.083 - 0.0420021)/0.3333 = 0.1230 or 12.30%

d) Debt-Equity ratio of 1 means that weight of debt in the capital is 50% (1/2) and weight of equity is also 50% (1/2)
WACC = (wd x rd) + (we x ke)
=> 0.083 = (0.5 x 0.063) + (0.5 x ke)
=> ke = (0.083 - 0.0315)/0.5 = 0.1030 or 10.30%

e) Debt-Equity ratio of 0 meant that there is no debt in the capital. In such scenario, Cost of Equity will be equal to WACC. So, it will be 8.3%.

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