Braxton Corp. has no debt but can borrow at 6.6 percent. The firm’s WACC is curr

Question

Braxton Corp. has no debt but can borrow at 6.6 percent. The firm’s WACC is currently 8.4 percent, and the tax rate is 35 percent.

What is the company’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 25 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 25 percent debt, what is the company’s WACC? (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 is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Braxton Corp. has no debt but can borrow at 6.6 percent. The firm’s WACC is currently 8.4 percent, and the tax rate is 35 percent.

Explanation / Answer

a) With no debt, Cost of unlevered equity, rsu = WACC = 8.4%

b) With debt, Cost of levered equity, rsl = rsu + (rsu - rd) x (1 - tax) x D/E

rd - cost of debt, D/E - Debt Equity ratio

rsl = 8.4% + (8.4% - 6.6%) x (1 - 35%) x 25/75 = 8.79%

c) With 40% debt,

rsl = 8.4% + (8.4% - 6.6%) x (1 - 35%) x 40/60 = 9.18%

d1) WACC = ws x rsl + wd x rd x (1 - tax)

= 75% x 8.79% + 25% x 6.6% x (1 - 35%)

= 7.67%

d2) WACC = ws x rsl + wd x rd x (1 - tax)

= 60% x 9.18% + 40% x 6.6% x (1 - 35%)

= 7.22%

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