Question

Harris, Inc., has equity with a market value of $22.3 million and debt with a market value of $11.15 million. Treasury bills that mature in one year yield 4 percent per year and the expected return on the market portfolio is 10 percent. The beta of the company's equity is 1.08. The company pays no taxes. a. What is the company's debt-equity ratio? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What is the company's weighted average cost of capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) c. What is the cost of capital for an otherwise identical all-equity company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Please Show all work and formulas

Answer 1

a

D/E = 11.15/22.3 = 0.5

b

D/A = D/(E+D)

D/A = 0.5/(1+0.5)

=0.3333

Weight of equity = 1-D/A

Weight of equity = 1-0.3333

W(E)=0.6667

Weight of debt = D/A

Weight of debt = 0.3333

W(D)=0.3333

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (expected return on the market - risk-free rate)

Cost of equity% = 4 + 1.08 * (10 - 4)

Cost of equity% = 10.48

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 4*(1-0)

= 4

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4*0.3333+10.48*0.6667

WACC =8.32%

c

Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate)

10.48 = Unlevered cost of equity+0.5*(Unlevered cost of equity-4)*(1-0)

Unlevered cost of equity = 8.32