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 debtequity 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 debtequity 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 debtequity 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 debtequity ratio of 0, the cost of equity is:
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 Spring '08
 NA
 Corporate Finance, Debt, Weighted average cost of capital, tc, 12%, 9.90%, 18.30%

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