Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?
WACC = [(1.0/1.8) × 0.145] + [(0.8/1.8) × 0.049] = 0.102333;
WACC = 0.102333 = [(1.0/1.70) × RE] + [(0.70/1.70) × 0.049; RE = 13.97 percent |
84.
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Percy's Wholesale Supply has earnings before interest and taxes of $106,000. Both the book and the market value of debt is $170,000. The unlevered cost of equity is 15.5 percent while the pre-tax cost of debt is 8.6 percent. The tax rate is 38 percent. What is the firm's weighted average cost of capital?
VU = [$106,000 × (1 - 0.38)]/0.155 = $424,000
VL = $424,000 + (0.38 × $170,000) = $488,600 VE = $488,600 - $170,000 = $318,600 RE = 0.155 + (0.155 - 0.086) × ($170,000/$318,600) × (1 - 0.38) = 0.177827 WACC = [($318,600/$488,600) × 0.177827] + [($170,000/$488,600) × 0.086 × (1 - 0.38)] = 13.45 percent |
85.
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East Side, Inc. has no debt outstanding and a total market value of $136,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 27 percent higher. If there is a recession, then EBIT will be 55 percent lower. East Side is considering a $54,000 debt issue with a 5 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,000 shares outstanding. Ignore taxes. If the economy enters a recession, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes.
Share price = $136,000/2,000 = $68
Shares repurchased = $54,000/$68 = 794.117647 Annual interest = $54,000 × 0.05 = $2,700 EPSNormal = ($12,000 - $2,700)/(2,000 - 794.117647) = $7.712195 EPSRecession = {[$12,000 × (1 - 0.55)] - $2,700}/(2,000 - 794.117647) = $2.239024 Percentage change = ($2.239024 - $7.712195)/$7.712195 = -70.97 percent |
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