Question

Ekson Energy, Inc. (EKS) is an energy company with a market debt-to-equity ratio of 3. Suppose its current cost of debt capital is 6%, and its cost of equity capital is 14%.

(a) Calculate EKS’s weighted average cost of capital assuming no taxes and asymmetric information, i.e. Modigliani Miller propositions I and II with no taxes are in place.

Part 2:

Suppose now that if EKS issues equity and uses the proceeds to repay its debt and reduce its debt-toequity ratio to 2, it will lower its debt cost of capital to 5.5%.

(b) Calculate the new WACC assuming MM propositions with no taxes hold.

(c) Calculate EKS’s cost of equity capital after this reduction in leverage.

Part 3:

Assume now that EKS issues even more equity and pays off its debt completely.

(d) Calculate EKS’s cost of equity capital now. (Notice that in this situation EKS is unlevered!)

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

& VD ( 1x D ENG - 01:18 = 17-03-2020 ... o X GL1163 X for - GF V GG GH GI GJ GK GL GM GN GO GPA D/E = Wd =D/V = We =E/V = 3 3/4 1/4 WACC = WACC = WACC = We*ke + Wd*kd (1/4)(14%) + (3/4)(6%) 8.00% (a) 1163 1164 1165 1166 1167 1168 1169 1170 1171 1172 1173 1174 1175 1176 1177 1178 1179 1180 1181 1182 1183 1184 WHEN TAXES ARE ABSENT, REDUCTION IN DEBT REDUCES ke BUT WACC DO NOT CHANGE ke = WACC + (WACC-kd)(D/E) ke = 8% + (8% -5.5%)(2) ke = 13.00% (c) :) D/E = Wd =D/V = We =E/V = 2/3 1/3 WACC = WACC = WACC = We*ke + Wd*kd (1/3)(13%) + (2/3)(5.5%) 8.00% (d) 1185 IF DEBT IS COMPLETELY PAID OFF AND IT IS ONLY EQUITY FINANCED AND THRE ARE NO TAXES WACC = ke =k0 = 8.00% 2207 1186 1 ... | LOAN OPTIONS pv, fv, annuity CAP STRU VALUE PM, PMT | loan with points LOCK BOX DILUTION DOLLAR COST AVG EXPO | NPER APR CPI ear ... + :