Question

Citee Corp. has no debt but can borrow at 5.2 percent. The firm’s WACC is currently 8.9 percent, and the tax rate is 24 percent.

  

a.	What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	If the firm converts to 25 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	If the firm converts to 45 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
d-1.	If the firm converts to 25 percent debt, what is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
d-2.	If the firm converts to 45 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 1

Hi,

a) With no debt company's cost of equity will be same WACC

hence cost of equity = 8.9%

b) With debt , cost of equity will become levered cost of equity

at 25%, cost of equity = cost of unlevered equity + D/E*(cost of unlevered equity - cost of debt)*(1- tax rate)

=8.9 + (25/75)*(8.9- 5.2)*(1-0.24)

=8.9 + 0.9373

=9.84%

c) at 45%, cost of equity = 8.9 + (45/55)*(8.9-5.2)*(1-0.24)

=8.9 + 2.3

=11.2%

d1) WACC at 25% = 0.25*5.2*(1-0.24) + 0.75*9.84

=0.988 + 7.38

=8.37%

d2) WACC st 45% = 0.45*5.2*(1-0.24) + 0.55*11.2

=1.7784 + 6.16

=7.94%

Thanks