Malkin Corp. has no debt but can borrow at 8 percent. The firm’s WACC is current

Question

Malkin Corp. has no debt but can borrow at 8 percent. The firm’s WACC is currently 16 percent, and there is no corporate tax.

If the firm converts to 10 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 60 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

a. Since there is no debt, Cots of equity = WACC = 16%

b. If the firm wants 10% debt, the weight of debt (Wd)= 0.10 and weight of equity (We)= 1-0.1 = 0.9

Cost of debt(Rd) = 8% and WACC = 16%. We need to find the cost of equity = Re = ?

WACC = Re*We + Rd* Wd

16 = 0.9*Re + 0.1*8

15.2 = 0.9Re

Re = 16.89%. Cost of equity = 16.89%

c. When debt = 60%, Wd = 0.6 and We = 0.4

0.6*8 + 0.4*Re = 16

0.4Re = 11.2

Re =28%

Cost of equity = 28%

d. The WACC does not change and will be 16% in both cases.

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