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Homework answers / question archive / Elliott's Cross Country Transportation Services has a capital structure with 25% debt at a 9% interest rate
Elliott's Cross Country Transportation Services has a capital structure with 25% debt at a 9% interest rate. Its beta is 1.5, the risk-free rate is 2%, and the market risk premium is 6%. Elliott's combined federal-plus-state tax rate is 25%.
a. Computation of Elliott's Cost of Equity:
Cost of Equity = Risk free Rate + Beta * Market Risk Premium
= 2%+1.5*6%
= 2% + 9%
Cost of Equity = 11%
b. Computation of Weighted Average Cost of Capital (WACC):
WACC = Weight of Debt * Cost of Debt * (1-tax rate) + Weight of Equity * Cost of Equity
= 25%*9%*(1-25%) + 75%*11%
= 1.69% + 8,25%
WACC = 9.94%
c. Computation of Unlevered Cost of Equity:
Debt-Equity Ratio = Weight of Debt / Weight of Equity
Debt-Equity Ratio = 0.25 / 0.75
Debt-Equity Ratio = 1/3
Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - tax) * Debt-Equity Ratio
0.11 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.09) * (1 - 0.25) * (1/3)
0.11 = Unlevered Cost of Equity + (Unlevered Cost of Equity - 0.09) * 0.25
0.11 = Unlevered Cost of Equity + 0.25 * Unlevered Cost of Equity - 0.0225
0.1325 = 1.25 * Unlevered Cost of Equity
Unlevered Cost of Equity = 0.1325/1.25 = 10.60%
