Question

Shadow Corp. has no debt but can borrow at 5.1 percent. The firm’s WACC is currently 8.7 percent and the tax rate is 25 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 20 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 55 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 20 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 55 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

a) 8.70% Re WACC| b) converts to 20 percent debt: Re Ra+(Ra-Rd)(D/E)(1-t) Ra unlevered cost of equity 9.38% 0.087+((0.087-0.051) *(0.2/0.8)*(0.75)) converts to 55 percent debt: c) Re Ra(Ra-Rd) (D/E) (1-t) unlevered cost of equity Ra 12.00% 0.087+((0.087-0.051)*(0.55/0.45) *(0.75)) d-1) d-2) converts to 30 percent debt: WACC converts to 55 percent debt: WACC: weight cost 0.45 12.00% Particulars weighted cost weighted cost 0.054 weight Particulars cost 9.38% Equity 0.8 0.075 Equity 0.00765 8.27% WACC 0.0210375 7.50% WACC Debt 3.83% Debt 0.55 3.83% 0.2