| Braxton Corp. has no debt but can borrow at 6.2 percent. The firm’s WACC is currently 8 percent, and the tax rate is 35 percent. |
| a. | 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.) |
| Cost of equity | % |
| b. | If the firm converts to 20 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.) |
| Cost of equity | % |
| c. | If the firm converts to 50 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.) |
| Cost of equity | % |
| d-1 | If the firm converts to 20 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.) |
| WACC | % |
| d-2 | If the firm converts to 50 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.) |
Answer
| (A) | % |
| Cost of Equity | 8% |
| (B) | |
| Cost of Equity | 6.40% |
| ( c ) | |
| Cost of Equity | 5% |
| (D)1 | |
| WACC | 7.21% |
| (D)2 | |
| WACC | 6.02% |
Working notes for the above answer is as under
WACC = w(d)*k(d)*(1-t) + w(e)*k(e)
Where:
w(d) = % debt in capital structure
w(e) = % equity in capital structure
k(d) = cost of debt
k(e) = cost of equity
t = tax rate
So:
a)
8% = 0% * 8.3% * (1-35%) + 100% * k(e)
8% = 100% * k(e)
k(e) = 8%
So your cost of equity with no debt is your WACC,
- b)
WACC = 20% * 6.2 * (1-35%) + 80% * 8%
Weighted cost of equity = 80% * 8% =6.4
d (for b): WACC = 20% * 4.03 * (1-35%) + 80% * 8%
=7.21%
- c)
WACC = 50% * 6.2 * (1-35%) + 50% * 8%
Weighted cost of equity = 50% * 8% = 5%d (for c): WACC = 50% * 4.03 * (1-35%) + 50% * 8%
= 6.02%
