Malkin Corp. has no debt but can borrow at 7.25 percent. The firm\'s WACC is cur

Question

Malkin Corp. has no debt but can borrow at 7.25 percent. The firm's WACC is currently 13 percent, and there is no corporate tax. What is Malkin's cost of equity? If the firm converts to 25 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 55 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).)

Explanation / Answer

Solution:

Given that cost of debt, kd = 7.25% and

WACC = 13%

(a) WACC = wd*kd*(1- t) + we*ke

13% = 0*7.25%*(1 – 0) + 100%*ke

13% = 0 + 100%*ke

Ke = 13%

Hence, the cost of equity is 13%.

(b) If the firms converts to 25% debt,

WACC = wd*kd*(1- t) + we*ke

13% = 0.25*7.25%*(1-0) + 0.75*ke

13% = 1.8125% + 0.75*ke

0.75*ke = 11.1875%

ke = 14.92%

Hence, the cost of equity is 14.92%

(c) If the firms converts to 55% debt,

WACC = wd*kd*(1- t) + we*ke

13% = 0.55*7.25%*(1-0) + 0.45*ke

13% = 3.9875% + 0.45*ke

0.45*ke = 9.0125%

ke = 20.03%

Hence, the cost of equity is 20.03%

d. WACC with 25% debt

WACC = wd*kd*(1- t) + we*ke

WACC = 25%*7.25%*(1 – 0) + 0.75*14.92%

WACC = 13%

WACC with 55% debt

WACC = wd*kd*(1- t) + we*ke

WACC = 55%*7.25%*(1 – 0) + 0.45*20.03%

WACC = 13%

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