Question

1. Suppose that QRY Corp. has an equity beta of 1.5. Current risk-free rates are 5% and the expected return on the market portfolio is 15%. QRY Corp has a market value debt-to-equity ratio of 0.5, debt that is rated AAA, and faces a 21% tax rate. QRY Corps debt is rate AAA and has an average maturity of 10 years. Assuming that the current market price of AAA bonds paying 5% semi-annual coupon, with 10 years maturity, and par value of $1000 is $850, compute QRY Corps WACC? Enter your answer as a percent without the % sign. Round to two decimals.

2.Suppose the HHY Corp has a WACC of 15%, a cost of debt capital of 5%, and a market value debt-to-equity ratio of 0.30. Assuming that HHY Corp. is not subject to taxation and its debt will remain risk-free, what will be HHY’s cost of equity capital if it raises its market value debt-to-equity ratio to 0.50? Enter your answer as a percent without the % sign. Round to two decimals.

Answer 1

Answer for question number 1 To compute the WACC of QRY Corp. follow the below mentioned steps: Step 1: Compute the weight of debt and equity as follows: Compute weight of debt as follows: _ Debt Weight of debt = Debt + Equity Divide numerator and denominator by "equity" Debt Equity Debt +Equity Equity 0.50 0.50+1 = 0.333333333 Hence, the weight of debt is 0.33 Compute the weight of equity as follows: Weight of equity=1- Weight of debt =1-0.333333333 = 0.666666667 Hence, the weight of equity is 0.67 Step 2: Compute the cost of equity as follows: Cost of equity = Risk-free rate+Betax(Market retun - Risk-free return) = 5%+1.50x(15%-5% =0.05 +0.15 = 0.20 Hence, the cost of equity is 20% Step 3: Compute the after-tax cost of debt as follows: The formulas and the inputs used is as follows: А Computation of YTM Annual coupon rate Par value Semi-annual coupon rate Maturity (years) Numner of periods Annual coupon payment Current selling price YTM Annual YTM Tax ratre After tax cost of debt 0.05 1000 =B2/2 10 =B5*2 =B4%B3 850 =RATE(B6,B7,-B8,B3) =B9*2 0.21 =B10*(1-B11) 10 The result is as follows: Computation of YTM Annual coupon rate Par value Semi-annual coupon rate Maturity (years) Numner of periods Annual coupon payment Current selling price YTM Annual YTM Tax ratre After tax cost of debt 5.00% $1,000.00 2.50% 10 20 $25.00 $850.00 3.5613% 7.12% 21% 5.62682% Hence, the after-tax cost of debt is 5.62682%

Step 4: Compute the WACC as follows: WACC = (After tax cost of debt x Weight of debt )+(Cost of equity x Weight of equity) =(5.62682%x0.33)+(20%x0.67) =0.018568506 +0.134000 = 0.152568506 Hence, the WACC is 15.26% Answer for question number 2 HHY is not subjected to taxation hence we will consider its cost of debt is equal to the after-tax cost of debt in the WACC calculation. First, we will calculate the cost of equity when the debt-equity ratio was 0.3 WACC = (Weight of debt * after-tax cost of capital) +(weight of equity * cost of equity) weight of debt, using the formula = 0.3/(1+0.3)=0.2308. weight of equity = 1/ (1+0.3) = 0.7692 plugging in the known values in the WACC formula mentioned, 15 = (0.2308 * 5) + (0.7692 * cost of equity) = 1.154+ (0.7692 * cost of equity) 15 - 1.154 = (0.7692 * cost of equity) Cost of equity=(15 - 1.154) 0.7692 = 18.00 Now, if the debt to equity ratio rises to 0.50, assuming everything else equal, weight of debt will be 0.5/(1+0.5) = 0.3333. Similarly, weight of equity will be 0.6667 WACC = (Weight of debt * after-tax cost of capital) +(weight of equity * cost of equity) plugging in the new values, 15 = (0.3333*5) + (0.6667 * cost of equity) 15 = 1.67 +(0.6667 * cost of equity) 15 - 1.67 = (0.6667 * cost of equity) (15 - 1.67)/ 0.6667 = cost of equity = 20.00