Malkin Corp. has no debt but can borrow at 7 percent. The firm’s WACC is current

Question

Malkin Corp. has no debt but can borrow at 7 percent. The firm’s WACC is currently 12 percent, and there is no corporate tax.

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 percentage rounded to 2 decimal places (e.g., 32.16).)

If the firm converts to 45 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

What is Malkin’s WACC in part (b) and (c)? (Do not round intermediate calculations. Enter your answers as a percentage rounded to the nearest whole number (e.g., 32).)

Malkin Corp. has no debt but can borrow at 7 percent. The firm’s WACC is currently 12 percent, and there is no corporate tax.

Explanation / Answer

WACC = Wd×Rd+We×Ke

W is weights of respective portfolios

R is return on respective portfolios

Wd+We = 1

Ke = (WACC-Wd×Rd)÷We

a)

Ke = 12%

b)

Ke = (12%-0.20×7%)÷0.80

= 13.25%

c)

Ke = (12%-0.45×7%)÷0.55

= 16.10%

d)

WACC = Wd×Rd+We×Ke

W is weights of respective portfolios

R is return on respective portfolios

Wd+We = 1

20% debt:

WACC = Wd×Rd+We×Ke

= 0.20×7%+0.8×13.25%

= 12%

45% debt:

WACC = Wd×Rd+We×Ke

= 0.45×7%+0.55×13.25%

= 10.44%

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