Twice Shy Industries has a debtequity ratio of 1.1. Its WACC is 7 percent, and i

Question

Twice Shy Industries has a debtequity ratio of 1.1. Its WACC is 7 percent, and its cost of debt is 5.6 percent. The corporate tax rate is 35 percent. a. What is the company’s cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity capital % b. What is the company’s unlevered cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Unlevered cost of equity capital % c-1 What would the cost of equity be if the debtequity ratio were 2? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity % c-2 What would the cost of equity be if the debtequity ratio were 1.0? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity % c-3 What would the cost of equity be if the debtequity ratio were zero? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

Explanation / Answer

a) debt equity ratio = 1.1, cost of debt = 5.6, tax rate = 35% total weight = 1.1+1=2.1

WACC= 1.1/2.1*5.6(1-0.35)+1/2.1X ( X is the cost of capital

7%= 1.9067+1/2.1X

0.476X= 5.0933%

X= 10.70%

b) unleavred cost of equity

7%= 0.5*5.6(1-0.35)+0.5X

7%= 1.82+0.5X

5.18%= 0.5X

X = 5.18/0.5

=10.36% this is the cost of unleavered cost of equity capital

c1)

debt equity ratio = 2, cost of debt = 5.6, tax rate = 35% total weight = 2+1=3

WACC= 2/3*5.6(1-0.35)+1/3X ( X is the cost of capital

7%= 2.4267+1/3X

0.333X= 4.5733%

X= 13.73%

c2)

debt equity ratio = 1, cost of debt = 5.6, tax rate = 35% total weight = 1+1=2

WACC= 1/2*5.6(1-0.35)+1/2X ( X is the cost of capital

7%= 0.5*5.6(1-0.35)+0.5X

7%= 1.82+0.5X

5.18%= 0.5X

X = 5.18/0.5

= 10.36%

c3)

debt equity ratio = 0, cost of debt = 5.6, tax rate = 35%

WACC= 0*5.6(1-0.35)+X ( X is the cost of capital

7%=0+X

X= 7%

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