Question

Dickson, Inc., has a debt-equity ratio of 2.25. The firm’s weighted average cost of capital is 10 percent and its pretax cost of debt is 7 percent. The tax rate is 22 percent.

a.	What is the company’s cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	What is the company’s unlevered cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	What would the company’s weighted average cost of capital be if the company's debt-equity ratio were .75 and 1.25? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

WACC = We x ke + Wd x Kd(after tax) 0.10 = (1/3.25) x ke +(2.25/3.25) x (0.0546) Ke = 20.22% Cost of Equity Re = Ra +(Ra-Rd)(D/E)(1-1) Ra = unlevered cost of equity Ra = 20.22% - [1.755Ra-1.755Rd] Ra = Unlevered cost of equity = 11.80% c) Ra = unlevered cost of equity If Debt equity = 0.75 cost of equity = Re = Ra +(Ra-Rd)(D/E)(1-t) = 14.60% 0.118+((0.118-0.07)*(0.75)*(0.78)) WACC = 10.68% (0.75/1.75*0.0546)+(1/1.75*0.146)

Ra = unlevered cost of equity If Debt equity = 1.25 cost of equity = Re - Ra +(Ra-Rd)(D/E)(1-t) = 16.47% 0.118+((0.118-0.07)*(1.25)*(0.78)) WACC = 10.35% (1.25/2.25*0.0546)+(1/2.25*0.1647)