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Homework answers / question archive / Shadow Corp
Shadow Corp. has no debt but can borrow at 6.6 percent. The firm's WACC is currently 8.4 percent, and the tax rate is 35 percent.
a). What is the firm's cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b). If the firm converts to 25 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c). If the firm converts to 40 percent debt, what will its cost of equity be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
d-1). If the firm converts to 25 percent debt, what will the company's WACC be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
d-2). If the firm converts to 40 percent debt, what will the company's WACC be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
a). Cost of equity = WACC = 8.40%
b). Computation of the cost of equity:-
Cost of equity = Unlevered cost of equity + ((Unlevered cost of equity - Cost of debt) * (D/E ratio) * (1-Tax rate))
= 8.4% + ((8.4%-6.6%)*(25%/(1-25%))*(1-35%))
= 8.4% + (1.80% * 0.33 * 65%)
= 8.4% + 0.39%
= 8.79%
c). Computation of the cost of equity:-
Cost of equity = Unlevered cost of equity + ((Unlevered cost of equity - Cost of debt) * (D/E ratio) * (1-Tax rate))
= 8.4% + ((8.4%-6.6%)*(40%/(1-40%))*(1-35%))
= 8.4% + (1.80% * 0.67 * 65%)
= 8.4% + 0.78%
= 9.18%
