15_Sol - 12. a. With the information provided, we can use...

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12. a. With the information provided, we can use the equation for calculating WACC to find the cost of equity. The equation for WACC is: WACC = (E/V)R E + (D/V)R D (1 – t C ) The company has a debt-equity ratio of 1.5, which implies the weight of debt is 1.5/2.5, and the weight of equity is 1/2.5, so WACC = .12 = (1/2.5)R E + (1.5/2.5)(.12)(1 – .35) R E = .1830 or 18.30% b. R E = R 0 + (R 0 – R D )(D/E)(1 – t C ) .1830 = R 0 + (R 0 – .12)(1.5)(1 – .35) R O = .1519 or 15.19% c. To find the cost of equity under different capital structures, we can again use M&M Proposition II with taxes. With a debt-equity ratio of 2, the cost of equity is: R E = R 0 + (R 0 – R D )(D/E)(1 – t C ) R E = .1519 + (.1519 – .12)(2)(1 – .35) R E = .1934 or 19.34% With a debt-equity ratio of 1.0, the cost of equity is: R E = .1519 + (.1519 – .12)(1)(1 – .35) R E = .1726 or 17.26% And with a debt-equity ratio of 0, the cost of equity is:
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15_Sol - 12. a. With the information provided, we can use...

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