I\'m having problems with c and d-2. Here\'s the question? Shadow Corp. has no d

Question

I'm having problems with c and d-2. Here's the question?

Shadow Corp. has no debt but can borrow at 6.7 percent. The firm’s WACC is currently 8.5 percent, and the tax rate is 35 percent.

What is Shadow’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

If the firm converts to 20 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

If the firm converts to 40 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

If the firm converts to 20 percent debt, what will the company's WACC be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

If the firm converts to 40 percent debt, what will the company's WACC be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

What is Shadow’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Cost of Equity (RE)
MM Proposi±on II
RE=RU+(RU–RD) X D/E X (1 – TC)
a. No Debt

ke = 8.5% + (8.5% - 6.7%) X 0% X (0.65) = 8.5%

b. 20% Debt

ke = 8.5% + (8.5% - 6.7%) X 25% X (0.65) = 8.35%

c. 40% Debt

Ke = 8.5% + (8.5% - 6.7%) X 66.67% X (0.65) = 8.11%

WACC = We X Re+ Wd X Rd X (1 – t)
d-1 20% Debt

WACC = 80% X 8.35%+ 20% X 6.7% X (0.65) = 7.55%

d-2 40% Debt

WACC = 60% X 8.11%+ 40%X 6.7% X (0.65) = 6.61%

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