Braxton Corp. has no debt but can borrow at 6.5 percent. The firm’s WACC is curr
ID: 2801132 • Letter: B
Question
Braxton Corp. has no debt but can borrow at 6.5 percent. The firm’s WACC is currently 8.3 percent, and the tax rate is 35 percent.
What is the company’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
If the firm converts to 15 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.)
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.)
If the firm converts to 15 percent debt, what is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
If the firm converts to 40 percent debt, what is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Braxton Corp. has no debt but can borrow at 6.5 percent. The firm’s WACC is currently 8.3 percent, and the tax rate is 35 percent.
Explanation / Answer
WACC = w(d)*k(d)*(1-t) + w(e)*k(e)
Where:
w(d) = % debt in capital structure
w(e) = % equity in capital structure
k(d) = cost of debt
k(e) = cost of equity
t = tax rate
a)
8.30% = 0% * 6.5% * (1-35%) + 100% * k(e)
8.30% = 100% * k(e)
k(e) = 8.30%
So the cost of equity with no debt is the WACC.
b)
If the firm converts to 15% debt, only the weighted cost that will change. The cost of equity will still be 8.30%.
Cost of Equity with 15% debt = 8.30%
c)
If the firm converts to 40% debt, only the weighted cost that will change. The cost of equity will still be 8.30%.
Cost of Equity with 40% debt = 8.30%
d-1:
WACC with 15% debt is:
WACC = 15% * 6.5% * (1-35%) + 85% * 8.30% = 7.6887%
WACC with 15% debt = 7.68%
d-2:
WACC with 40% debt is:
WACC = 40% * 6.5% * (1-35%) + 60% * 8.30% = 6.67%
WACC with 40% debt = 6.67%