Question

Blitz Industries has a debt-equity ratio of 1.7. Its WACC IS 8.1 percent, and its cost of debt Is 5.7 percent. The corporate tax rate is 23 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-1. What would the cost of equity be if the debt-equity ratio were 2? (Do not round Intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) C-2. What would the cost of equity be if the debt-equity ratio were 1.0? (Do not round Intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) c-3. What would the cost of equity be if the debt-equity ratio were zero? (Do not round Intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity Unlevered cost of equity c-1. Cost of equity c-2. Cost of equity c-3. Cost of equity

Answer 1

Answer a.

Debt-Equity Ratio = 1.70

Weight of Debt = 1.70/2.70
Weight of Equity = 1.00/2.70

WACC = Weight of Debt * Cost of Debt * (1 - Tax Rate) + Weight of Equity * Levered Cost of Equity
0.0810 = (1.70/2.70) * 0.0570 * (1 - 0.23) + (1.00/2.70) * Levered Cost of Equity
0.0810 = 0.027634 + (1.00/2.70) * Levered Cost of Equity
0.053366 = (1.00/2.70) * Levered Cost of Equity
Levered Cost of Equity = 0.1441 or 14.41%

Answer b.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - Tax Rate) * Debt-Equity Ratio
0.1441 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.0570) * (1 - 0.23) * 1.70
0.1441 = Unlevered Cost of Equity + 1.309 * Unlevered Cost of Equity - 0.074613
0.218713 = 2.309 * Unlevered Cost of Equity
Unlevered Cost of Equity = 0.0947 or 9.47%

Answer c-1.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - Tax Rate) * Debt-Equity Ratio
Levered Cost of Equity = 0.0947 + (0.0947 - 0.0570) * (1 - 0.23) * 2.00
Levered Cost of Equity = 0.0947 + 0.0581
Levered Cost of Equity = 0.1528 or 15.28%

Answer c-2.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - Tax Rate) * Debt-Equity Ratio
Levered Cost of Equity = 0.0947 + (0.0947 - 0.0570) * (1 - 0.23) * 1.00
Levered Cost of Equity = 0.0947 + 0.0290
Levered Cost of Equity = 0.1237 or 12.37%

Answer c-3.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - Tax Rate) * Debt-Equity Ratio
Levered Cost of Equity = 0.0947 + (0.0947 - 0.0570) * (1 - 0.23) * 0.00
Levered Cost of Equity = 0.0947 + 0.0000
Levered Cost of Equity = 0.0947 or 9.47%