Question

When the company has no debt, what happens to re, ru and the wacc? how do i compute them? and if there is debt?

Answer 1

When there is no debt, the cost of equity is equal to cost of unlevered equity which is equal to weighted average cost of capital.

Weighted average cost of capital uses percentage of debt and percentage of equity as weights and takes into account their cost to arrive at wacc as under

Wacc = (%debt)*(cost of debt)*(1-tax) + (%equity)*(cost of equity)

Where % debt = Total debt/total capital

% equity = 1-%debt

Unlevered equity means that there is no debt. When there is no debt in wacc formula it simply becomes 100% equity * cost of equity = cost of equity itself

Cost of levered equity is given as under

Re = Ru + (debt/equity)*(Ru-Rb)*(1-tax)

Where Re is cost of levered equity (capital has debt too)

Ru is cost of unlevered equity

Rb is cost of debt

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