Skillet Industries has a debt–equity ratio of 1.4. Its WACC is 9.4 percent, and
ID: 2741747 • Letter: S
Question
Skillet Industries has a debt–equity ratio of 1.4. Its WACC is 9.4 percent, and its cost of debt is 6.7 percent. The corporate tax rate is 35 percent.
a. What is the company’s cost of equity capital? (Round your answer to 2 decimal places. (e.g., 32.16)) Cost of equity capital %
16.46% Is Correct
b. What is the company’s unlevered cost of equity capital? (Round your answer to 2 decimal places. (e.g., 32.16)) Unlevered cost of equity capital %
38.71% Incorrect
c-1 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)) Cost of equity %
19.49% Incorrect
c-2 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)) Cost of equity %
14.45% Incorrect
c-3 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)) Cost of equity %
9.40 Incorrect
Explanation / Answer
Solution B
We can use following formula to compute unlevered cost of equity
Re (Lev) = Re (Unl) + D/ E ( Re(unl) –Rd) x (1-tax rate)
0.1646 = Re(Unl) + 1.4( Re(Unl – 0.067) x (1-0.35)
0.1646 = Re (Unl) +0.91 Rr(Unl) – 0.06097
Re(Unl) = 0.22557/1.91
Re(Unl) = 11.81%
Solution C-1
Re (Lev) = Re (Unl) + D/ E ( Re(unl) –Rd) x (1-tax rate)
= 0.1181 + 2 x ( 0.1181 – 0.067) x (1-0.35)
= 0.1181 + 0.06643
= 18.45%
Solution C-2
Re (Lev) = Re (Unl) + D/ E ( Re(unl) –Rd) x (1-tax rate)
= 0.1181 + 1 x ( 0.1181 – 0.067) x (1-0.35)
= 0.1181 + 0.033215
= 15.13%
Solution C-3
Re (Lev) = Re (Unl) + D/ E ( Re(unl) –Rd) x (1-tax rate)
= 0.1181 + 0x ( 0.1181 – 0.067) x (1-0.35)
= 0.1181 + 0
= 11.81%
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