Question

Malkin corp. has no debt but can borrow at 8.75 percent. the firm’s wacc is currently 16 percent, and there is no corporate tax. required: (a what is malkin’s cost of equity?% (b if the firm converts to 15 percent debt, what will its cost of equity be?% (c if the firm converts to 50 percent debt, what will its cost of equity be?% (d what is malkin’s wacc in part (b and (c?

Answer 1

Answer:

a.

16%

b.

17.3%

c.

23.25%

d.

16%

Explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

As have the cost of capital, we need to calculate the cost of equity.

Cost of Capital = (Cost of Equity x Weightage of equity) + (Cost of Debt x Weightage of Debt)

a.

No Debt

16% = (Cost of Equity x 1 ) + (8.75% x 0)

16% = Cost of Equity + 0

Cost of Equity = 16%

b.

15% Debt and Equity is 85% (100%-15%)

16% = (Cost of Equity x 85% ) + (8.75% x 15%)

0.16 = (Cost of Equity x 0.85) + 0.013125

0.16 - 0.013125 = Cost of Equity x 0.85

0.146875 = Cost of Equity x 0.85

Cost of Equity = 0.146875 / 0.85 = 0.17279

Cost of Equity = 17.3%

c.

50% Debt and Equity is 50% (100%-50%)

16% = (Cost of Equity x 50% ) + (8.75% x 50%)

0.16 = (Cost of Equity x 0.50) + 0.04375

0.16 - 0.04375 = Cost of Equity x 0.50

0.11625 = Cost of Equity x 0.50

Cost of Equity = 0.11625 / 0.50 = 0.2325

Cost of Equity = 23.25%

d.

WACC for b and c are 16%

Answer 2

Answer:

A) 16%

B) 17.28%%

C) 23.25%

D) debt = 15%, WACC ⇒ 16%

debt = 50%, WACC ⇒ 16%

Explanation:

WACC = weighted average cost of capital is the rate at which the company effectively finances its assets.

The formula used to calculate WACC is:

WACC = {[total equity/(total debt + equity)] x cost of equity} +  {[total debt/(total debt + equity)] x cost of debt x (1 - tax rate)}

A) equity = 100%

WACC = cost of equity = 16%

B) Modigliani-Miller proposition II, changes the cost of equity once debt increases using the following formula

= old cost of equity + [(old cost of equity - cost of debt)x(debt/equity)x(1 - taxes)]

equity = 85%, debt = 15%

cost of equity = 16% + [(16% - 8.75)x(0.15/0.85)] = 16% + 1.28% = 17.28%

C) equity = 50%, debt = 50%

cost of equity = 16% + [(16% - 8.75)x(.5/.5)] = 16% + 7.25% = 23.25%

D) Since there are no corporate taxes, the WACC will not decrease by taking debt.

equity = 85%, debt = 15%

WACC = (0.85 x 17.28%) + (.15 x 8.75%) = 14.69% + 1.31% = 16%

equity = 85%, debt = 15%

WACC = (0.50 x 23.25%) + (.5 x 8.75%) = 11.625% + 4.375% = 16%