Question

Blitz Industries has a debt-equity ratio of .7. Its WACC is 8.9 percent, and its cost of debt is 6.2 percent. The corporate tax rate is 21 percent. |

a. |
What is the company’s cost of equity capital? |

b. |
What is the company’s unlevered 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.) |

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.g.,
32.16.) |

c-2. |
What would the cost of equity be if the debt-equity ratio were
1.0? |

c-3. |
What would the cost of equity be if the debt-equity ratio were
zero? |

Answer #1

**(a)** Debt-to-Equity Ratio = DE = 0.7, WACC = 8.9
%, Cost of Debt = 6.2 % = kd and Corporate Tax Rate = T = 21 %

Let the cost of equity be ke

Therefore, WACC = ke x (E/V) + kd x (1-T) x (D/V) = ke x (1/1.7) + 6,2 x (1-0.21) x (0.7/1.7) = 8.9

ke x (1/1.7) = 6.8832

ke = 6.8832 x 1.7 = 11.7014 %

**(b)** Let the unlevered cost of equity be Ru

Therefore, 11.7014 = Ru + DE x (1-T) x (Ru - 6.2)

11.7014 = Ru + 0.7 x (1-0.21) x (Ru - 6.2) = Ru + 0.553 Ru - 3.4286

1.553 Ru = 15.13

Ru = 15.13 / 1.553 ~ 9.74 %

**(c1)** If debt to equity ratio is 2 and let the
cost of equity be r1

Therefore, r1 = 9.74 + (1-0.21) x 2 x (9.74 - 6.2) = 15.33 %

**(c2)** If debt to equity ratio is 1 and let the
cost of equity be r2

Therefore, r2 = 9.74 + (1-0.21) x 1 x (9.74 - 6.2) = 12.54 %

**(c3)** If debt to equity ratio is 0 and let the
cost of equity be r3

Therefore, r3 = 9.74 + (1-0.21) x 0 x (9.74 - 6.2) = 9.74 %

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