Weston Industries has a debt-equity ratio of 1.7. Its WACC is 9.6 percent, and i

Question

Weston Industries has a debt-equity ratio of 1.7. Its WACC is 9.6 percent, and its pretax cost of debt is7 percent. The corporate tax rate is 35 percent. a. What is the company's cost of equity capital? (Do not round intermediate calculations and 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 unl not round intermediate calculations 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 debt-equity ratio were 2? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.9y 32.16.) c-2. What would the cost of equity be if the debt-equity ratio were 1.0? (Do not round intermediate calculations and 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 debt-equity ratio were zero? (Do not round intermediate 9.60 % ost o Hints eBook & Resources

Explanation / Answer

cost of debt Kd = d*(1-tax) = 7*(1-0.35) = 7*0.65 = 4.55

Formula for WACC = We*Ke + Wd*Kd = 9.6

answer a. Debt to equity of 1.7
Debt to equity = debt/equity, where debt is 1.7 and equity is 1
Thus the weight of debt in the company WD: = debt / debt + equity = 1.7 / 1.7+1 = 1.7/2.7 = 0.6296
and weight of equity We: will be 1-debt = 1-0.6296 = 0.3704
hence,
WACC = We*Ke + Wd*Kd
9.6 = 0.3704Ke + 0.6296*4.55
9.6 = 0.3704Ke + 2.86468
9.6-2.86468 / 0.3704 = Ke
Ke = 18.1839%

Answer b. With debt to equity given in the question C-3 of Zero, the debt is zero in this case and thus equity is complete 100% in the company. This is also called unlevered company and thus unlevered cost of equity = 9.6 (as given in answer of C-3)


Answer C-1. Debt to equity of 2
Debt to equity = debt/equity, where debt is 2 and equity is 1
Thus the weight of debt in the company WD: = debt / debt + equity = 2 / 2+1 = 2/3 = 0.667
and weight of equity We: will be 1-debt = 1-0.667 = 0.333
hence,
WACC = We*Ke + Wd*Kd
9.6 = 0.333Ke + 0.667*4.55
9.6 = 0.333Ke + 3.03485
9.6-3.03485 / 0.333 = Ke
Ke = 19.715%


Answer C-2: Debt to equity is 1
Debt to equity = debt/equity, where debt is 1 and equity is 1
Thus the weight of debt in the company WD: = debt / debt + equity = 1 / 1+1 = 1/2 = 0.5
and weight of equity We: will be 1-debt = 1-0.5 = 0.5
hence,
WACC = We*Ke + Wd*Kd
9.6 = 0.5Ke + 0.5*4.55
9.6 = 0.5Ke + 2.275
9.6-2.275 / 0.5 = Ke
Ke = 14.65%

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