Question

Gulf Coast Tours currently has a weighted average cost of capital of 12.4 percent based on a combination of debt and equity financing. The firm has no preferred stock. The current debt-equity ratio is .47 and the aftertax cost of debt is 6.1 percent. The company just hired a new president who is considering eliminating all debt financing. All else constant, what will the firm's cost of capital be if the firm switches to an all-equity firm?

Answer 1

Answer:

15.36 percent.

Explanation:

WACC= We * Ke + Wd * Kd

Where,

We = Weight of equity

Wd = Weight of debt

Ke = Cost of equity

Kd = Post tax cost of debt = 6.1%

0.124 = (1/1.47)(x) + (0.47/1.47)(0.061)

The right hand side of the equation was solved using the Least common factor method.

O.124 =( X + 0.02867)/1.47

0.124 x 1.47 = X + 0.02867

0.18228 - 0.02867 = X

0.15361 = X

0.1536 × 100

= 15.36