Common stocks of the Anders Company which currently has no debt in its capital structure are trading for $50 a share. Threes has 2 million shares outstanding now. Threes Co. uses the CAPM in estimating costs of capital. The (unlevered) equity beta for Threes Co. is 1.25, and the risk-free rate and the market portfolio return are expected to be 5% and 13%, respectively. Its income tax rate is 35%.

Mr. Anderson, the Vice-President of Finance, is considering changing its financing policy to actively maintain a target debt ratio of 20% (or 25% debt-to-equity ratio) of the levered firm. An investment bank informed him that Threes may be able to issue 10-year $1,000 par bonds for $922.05 per bond if it offers 4.0% annual coupons, or for $1,116.92 per bond if it offers 6.5% annual coupons. Coupons will be paid semi-annually. Threes plans to keep refinancing bonds at maturity to effectively make bonds perpetual.

Compute: i) cost of equity at the target leverage ratio, ii) cost of debt, and iii) the WACC of the Anders Co.

Solution Preview

1. Cost of equity using CAPM = Rf + (Rm-Rf) beta where
Rf = risk free rate = 5%
Rm = market return = 13%
beta = levered beta
We are given the unlevered beta = 1.25. The levered beta is calculated as
Levered Beta = Unlevered BetaX(1 + ...

Solution Summary

The solution explains the calculation of cost of equity,cost of debt and WACC

A company has a debt-equity ratio of 1.5. Its WACC is 14%, and its cost of debt is 9%. There is no corporate tax.
A. What is the company's cost of equity capital?
B. What would the cost of equity be if the debt-equity ratio were 1.0? What if it were 0.5? What is it were 0?

A firm has a debt-to-equity ration of 1. Its (levered) cost of equity is 16% and its cost of debt is 8%. If there were no taxes, What would be its cost of equity if the debt-to-equity ratio were zero?
A company has a debt to total value ratio of 0.5 . The cost of debt is 8% and that of unlevered equity is 12%. Calculate the

First question: What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.
I understand that the answer is 66.7%
I am using the WACC formula WACC = E/V * Re + D/V *Rd * (1-Tc) Where Re = Cost of equity; Rd = cost of debt; E= mark

If a firm has a balance sheet with 50% debtand 50% equity,cost of debt of 6%, tax rate of 35%, and a cost of equity of 12%, what is the firms weighted average cost of capital?

A firm currently has a debt-equity ratio of 1/2. The debt, which is virtually riskless, pays an interest rate of 6 percent. The expected rate of return on the equity is 12 percent. What would happen to the expected rate of return on equity if the firm reduced its debt-equity ratio to 1/3? Assume the firm pays no taxes.
I have

A Corp. has no debt but can borrow at 8 %. The firm's WACC is currently 12% and has tax rate of 35%.
a. What is the cost of equity?
b. If the Corp. converts to 25 % debt,what will cost of equity be? 50 %?
c. What is shadow's WACC for part b: 25 % and 50 %.

In March 2007, Hertz Pain Relievers bought a massage machine that provided a return of 8 percent. It was financed by debtcosting 7 percent. In August 2007, Mr. Hertz came up with a heating compound that would have a return of 14 percent. The CFO, Mr. Smith, told him it was impractical because it would require the issuance of

What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.
A) 54.0%
B) 60.0%
C) 66.7%
D) 75.0%
A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%. What debt-equity ratio should be

Calculate the WACC for a firm with a debt-equity ratio of 1.5. The debt pays 6% interest and the equity is expected to return 8%. Assume a 35% tax rate and risk-free debt.

Smith and Jones Widget company has total capital, consisting of long-term debtand common equity of $80 million. Thirty-two million of total capital is in the form of long-term debt, which carries a cost of 12 percent. The company's equity carries a cost of 19.50 percent. If the company's tax rate is 38 percent, what is the W