Question

Blitz Industries has a debt equity ratio of 1.5. Its WACC is 77 percent, and its cost of debt! is 5.4 percent. The corporate tax rate is 25 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 Cost of equity

Answer 1

Answer:

As per the given Question

Answer a.

WACC = Weight of Debt * Cost of Debt * (1 - tax) + Weight of Equity * Cost of Equity
0.0770 = (1.5/2.5) * 0.0540 * (1 - 0.25) + (1.0/2.5) * Cost of Equity
0.0770 = 0.0243 + 0.40 * Cost of Equity
0.0527 = 0.40 * Cost of Equity
Cost of Equity = 0.1318 or 13.18%

Answer b.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - tax) * (D/E Ratio)
0.1318 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.0540) * (1 - 0.25) * 1.50
0.1318 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.0540) * 1.125
0.1318 = Unlevered Cost of Equity + 1.125 * Unlevered Cost of Equity - 0.06075
0.19255 = 2.125 * Unlevered Cost of Equity
Unlevered Cost of Equity = 0.0906 or 9.06%

Answer c-1.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - tax) * (D/E Ratio)
Levered Cost of Equity = 0.0906 + (0.0906 - 0.0540) * (1 - 0.25) * 2.00
Levered Cost of Equity = 0.0906 + 0.0549
Levered Cost of Equity = 0.1455 or 14.55%

Answer c-2.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - tax) * (D/E Ratio)
Levered Cost of Equity = 0.0906 + (0.0906 - 0.0540) * (1 - 0.25) * 1.00
Levered Cost of Equity = 0.0906 + 0.0275
Levered Cost of Equity = 0.1181 or 11.81%

Answer c-3.

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - tax) * (D/E Ratio)
Levered Cost of Equity = 0.0906 + (0.0906 - 0.0540) * (1 - 0.25) * 0.00
Levered Cost of Equity = 0.0906 + 0.0000
Levered Cost of Equity = 0.906 or 9.06%

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