Answer:
A) 16%
B) 17.28%%
C) 23.25%
D) debt = 15%, WACC ⇒ 16%
debt = 50%, WACC ⇒ 16%
Explanation:
WACC = weighted average cost of capital is the rate at which the company effectively finances its assets.
The formula used to calculate WACC is:
WACC = {[total equity/(total debt + equity)] x cost of equity} + {[total debt/(total debt + equity)] x cost of debt x (1 - tax rate)}
A) equity = 100%
WACC = cost of equity = 16%
B) Modigliani-Miller proposition II, changes the cost of equity once debt increases using the following formula
= old cost of equity + [(old cost of equity - cost of debt)x(debt/equity)x(1 - taxes)]
equity = 85%, debt = 15%
cost of equity = 16% + [(16% - 8.75)x(0.15/0.85)] = 16% + 1.28% = 17.28%
C) equity = 50%, debt = 50%
cost of equity = 16% + [(16% - 8.75)x(.5/.5)] = 16% + 7.25% = 23.25%
D) Since there are no corporate taxes, the WACC will not decrease by taking debt.
equity = 85%, debt = 15%
WACC = (0.85 x 17.28%) + (.15 x 8.75%) = 14.69% + 1.31% = 16%
equity = 85%, debt = 15%
WACC = (0.50 x 23.25%) + (.5 x 8.75%) = 11.625% + 4.375% = 16%
a.) Because this firm has no debt cause, the cost of equity of the firm is going to be 16%
b.) If this firm should convert to 15 percent debt, the cost of its equity is going to be calculated as
[tex]\frac{16+0.15}{1-0.15} *16-8.75\\\\= 17.28%[/tex]
c.) If the firm converts to a 50 percent debt the cost of equity is going to be
[tex]\frac{16+0.5}{1-0.5} *16-8.75\\\\= 23.25%[/tex]
d) WACC in part b
[tex]0.15*8.75+(1-0.15)*17.28 = 16%[/tex]
= 16%
d.) Wacc in part c
[tex]0.5*8.75+(1-.5)*23.25 = 16%[/tex]
= 16 percent
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