Weston Industries has a debt–equity ratio of 1.5. Its WACC is 11 percent, and its cost of debt is 7 percent. The corporate tax rate is 35 percent. What is Weston’s cost of equity capital? What is Weston’s unlevered cost of equity capital? What would the cost of equity be if the debt–equity ratio were 2? What if it were 1.0? What if it were zero?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question 4
- Weston Industries has a debt–equity ratio of 1.5. Its WACC is 11 percent, and its cost of debt is 7 percent. The corporate tax rate is 35 percent.
- What is Weston’s
cost of equity capital? - What is Weston’s unlevered cost of equity capital?
- What would the cost of equity be if the debt–equity ratio were 2? What if it were 1.0? What if it were zero?
- Shadow Corp. has no debt but can borrow at 8 percent. The firm’s WACC is currently 11 percent, and the tax rate is 35 percent.
- What is Shadow’s cost of equity?
- If the firm converts to 25 percent debt, what will its cost of equity be?
- If the firm converts to 50 percent debt, what will its cost of equity be?
- What is Shadow’s WACC in part (b)? In part (c)?
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
