CORPORATE FINANCE

WEIGHTED AVERAGE COST OF CAPITAL - HOMEWORK

NAME: Natalie Rosero Pasmay

GROUP: 1801
DATE: 23/01/2020

EXERCISES
1. Calculating WACC Mullineaux Corporation has a target capital structure
of 70 percent common stock and 30 percent debt. Its cost of equity is 15
percent, and the cost of debt is 8 percent. The relevant tax rate is 35
percent.
What is Mullineaux’s WACC?
DATA
We: 70%
Wd: 30%
Re: 15%
Rd: 8%
TC: 35%
WACC=?
𝑊𝐴𝐶𝐶 = 𝑊𝑒 ∗ 𝑟𝑒 + 𝑊𝑑 ∗ 𝑟𝑑(1 − 𝑡𝑐)
𝑊𝐴𝐶𝐶 = 0,70 ∗ 0,15 + 0,30 ∗ 0,08(1 − 0,35)
𝑊𝐴𝐶𝐶 = 0.105 + 0.0156
𝑊𝐴𝐶𝐶 = 0.1206 = 12.06%

2. Taxes and WACC Miller Manufacturing has a target debt–equity ratio of

.45. Its cost of equity is 17 percent, and its cost of debt is 10 percent. If the
tax rate is 35 percent, what is Miller’s WACC?
DATA
Debt-equity= 45
0.45 0.45
Rd= 10% 𝐷𝑒𝑏𝑡 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑊𝑑 = 1.45 = 0.3103 = 31%
1
1
Re= 17% 𝑊𝑒 = 1.45 = 0.68.97 = 68.97%
Tc= 35%
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
𝑊𝐴𝐶𝐶 = 0.68.97(0.17) + 0.3103 × 0.10(1 − 0.35)
𝑊𝐴𝐶𝐶 = 0.1374 = 13.74%

3. Finding the Capital Structure Fama’s Llamas has a weighted average

cost of capital of 9.8 percent. The company’s cost of equity is 15 percent,
and its cost of debt is 7.5 percent. The tax rate is 35 percent.
What is Fama’s debt–equity ratio?
WAAC= 9.8%
Re= 15% 𝑊𝑒 + 𝑊𝑑 = 1
Rd= 7.5% 𝑊𝑒 = 1 − 𝑊𝑑
Tc= 35%
𝑊𝐴𝐴𝐶 = 𝑊𝑒 𝑅𝑒 + 𝑊𝑑 𝑅𝑑 (1 − 𝑇𝑐)
0,098 = 𝑊𝑒 0,15 + 𝑊𝑑 0,075 (1 − 0,35)
0,098 = (1 − 𝑊𝑑)0,15 + 𝑊𝑑 0.075 (1 − 0.35)
0,098 = 0,15 − 0,15𝑊𝑑 + 𝑊𝑑 0.075 − 0,02625
0,098 = 0,15 − 0,15𝑊𝑑 + 0,04875𝑊𝑑
0,098 = 0,15 − 0,10125𝑊𝑑
0,098 − 0,15 = −0,10125𝑊𝑑
−0,052 = −0,10125𝑊𝑑
−0,052
= 𝑊𝑑
−0,10125
0,513580 = 𝑊𝑑 ≅ 51,36% Wd

4. WACC Kose, Inc., has a target debt–equity ratio of .65. Its WACC is 11.2
percent, and the tax rate is 35 percent.
DATA
0.65
WACC= 11.2% 𝑊𝑑 = 1+0.65 = 0.3939 = 39.39%
1
Tax rate (Tc) = 35% 𝑊𝑒 = 1+0.65 = 0.6061 = 60.61%
Debt-equity= 65%
Wd=?
We=?
a) If Kose’s cost of equity is 15 percent, what is its pretax cost of debt?
Cost of equity (re) =15%
Cost of debt (rd) =?
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
0.112 = 0.6061(0.15) + 0.3939𝑟𝑑(1 − 0.35)
0.112 = 0.090915 + 0.256035𝑟𝑑
0.112 − 0.090915 = 0.256035𝑟𝑑
0.021085
= 𝑟𝑑
0.256035
𝑟𝑑 = 0.0824 = 8.24%

b) If instead you know that the after tax cost of debt is 6.4 percent, what is
the cost of equity?
Cost of equity (re) =?
Cost of debt (rd) = 6.4%
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
0.112 = 0.6061𝑟𝑒 + 0.3939(0.064)(1 − 0.35)
0.112 = 0.6061𝑟𝑒 + 0.01638624
0.112 − 0.01638624 = 0.6061𝑟𝑒
0.09561376
= 𝑟𝑒
0.6061
𝑟𝑒 = 0.1578 = 15.78%

5. Calculating WACC Maxwell Industries has a debt–equity ratio of 1.5. Its

WACC is 10 percent, and its cost of debt is 7 percent. The corporate tax
rate is 35 percent.
DATA
WACC: 10%
TC: 35%
Rd: 7%
Wd: 15%
1. What is the company’s cost of equity capital?
𝑊𝐴𝐶𝐶 = We ∗ Re + Wd ∗ Rd(1 − TC) + Wp ∗ Rp
1 1.5
0.10 = ( ) 𝑅𝑒 + ( ) (0.07)(1 − 0.35)
2.5 2.5
1 1.5
0.10 − ( ) (0.07)(1 − 0.35) = ( ) 𝑅𝑒
2.5 2.5
0.0727
= 𝑅𝑒
1
2.5
0.18175 = 𝑅𝑒
𝑅𝑒 = 18.18%

2. What is the company’s unlevered cost of equity capital?

𝐷
𝑅𝑒 = Ru + (Ru − Rd)( )(1 − TC)
𝐸
0.1818 = Ru + (Ru − 0.07)(1.5)(1 − 0.35)
0.1818 = Ru + (Ru − 0.07)(0.975)
0.1818 = Ru + 0.975Ru − 0.06825
0.1818 + 0.06825 = 1.975Ru
0.25005
= 𝑅𝑢
1.975
𝑅𝑢 = 0.1266 = 12.66%

3. What would the cost of equity be if the debt–equity ratio were 2?

𝐷
𝑅𝑒 = Ru + (Ru − Rd)( )(1 − TC)
𝐸
𝑅𝑒 = 0.1266 + (0.1266 − 0.07)(2)(1 − 0.35)
𝑅𝑒 = 0.1266 + 0.07358
𝑅𝑒 = 0.20018 = 20.02%

 What if it were1.0?
𝐷
𝑅𝑒 = Ru + (Ru − Rd)( )(1 − TC)
𝐸
𝑅𝑒 = 0.1266 + (0.1266 − 0.07)(1)(1 − 0.35)
𝑅𝑒 = 0.1266 + 0.03679
 𝑅𝑒 = 0.16339 = 16.34%

 What if it were zero?

𝐷
𝑅𝑒 = Ru + (Ru − Rd)( )(1 − TC)
𝐸
𝑅𝑒 = 0.1266 + (0.1266 − 0.07)(0)(1 − 0.35)
𝑅𝑒 = 0.1266 + 0
𝑅𝑒 = 0.1266 = 12.66%

6. Calculating WACC Empress Corp. has no debt but can borrow at 8.2
percent. The firm’s WACC is currently 11 percent, and the tax rate is 35
percent.
DATA
Cost of debt (rd) = 8.2%
WACC= 11%
Tax rate (Tc) = 35%
Wd= 0
We= 100%
a) What is the company’s cost of equity?
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
0.11 = 1𝑟𝑒 + 0(0.082)(1 − 0.35)
0.11
𝑟𝑒 = = 0.11 = 11%
1

b) If the firm converts to 25 percent debt, what will its cost of equity be?
𝑊𝑒 = 1 − 𝑊𝑑
𝑊𝑒 = 1 − 25%
𝑊𝑒 = 75%
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
0.11 = 0.75𝑟𝑒 + 0.25(0.082)(1 − 0.35)
0.11 = 0.75𝑟𝑒 + 0.013325
0.11 − 0.013325 = 0.75𝑟𝑒
0.09675
= 𝑟𝑒
0.75
 𝑟𝑒 = 0.1289 = 12.89%

c) If the firm converts to 50 percent debt, what will its cost of equity be?
𝑊𝑒 = 1 − 𝑊𝑑
𝑊𝑒 = 1 − 50%
𝑊𝑒 = 50%
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
0.11 = 0.50𝑟𝑒 + 0.50(0.082)(1 − 0.35)
0.11 = 0.50𝑟𝑒 + 0.02665
0.11 − 0.02665 = 0.50𝑟𝑒
0.08335
= 𝑟𝑒
0.50
𝑟𝑒 = 0.1667 = 16.67%

d) What is the company’s WACC in part (b)? In part (c)?

PART B
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
𝑊𝐴𝐶𝐶 = 0.75(0.1289) + 0.25(0.082)(1 − 0.35)
𝑊𝐴𝐶𝐶 = 0.096675 + 0.013325
𝑊𝐴𝐶𝐶 = 0.110075 = 11%
PART C
𝑊𝐴𝐶𝐶 = 𝑊𝑒𝑟𝑒 + 𝑊𝑑𝑟𝑑(1 − 𝑇𝑐)
𝑊𝐴𝐶𝐶 = 0.50(0.1667) + 0.50(0.082)(1 − 0.35)
𝑊𝐴𝐶𝐶 = 0.08335 + 0.02665
𝑊𝐴𝐶𝐶 = 0.11 = 11%

7. Longstreet Communications Inc. (LCI) has the following capital

structure, which it considers to be optimal: debt = 25%, preferred stock =
15%, and common stock =60%. LCI’s tax rate is 40%, and investors expect
earnings and dividends to grow at a constant rate of 6% in the future. LCI
paid a dividend of $3.70 per share last year (D0), and its stock currently
sells at a price of $60 per share. Preferred stocks are sold in the market
at $50 with an annual dividend of $4. According the last financial
statements, LCI issued 10,000 bonds that were sold at a face value of $10
which caused $20,000 in interest expenses paid to bondholders.
What is the LCI´s W.A.C.C.?
4
𝑹𝑷 = = 0.08 ≅ 8%
50
2
𝑹𝑫 = = 0.2 ≅ 20%
10
3,70
𝑹𝑬 = + 0.06 = 0.1217 ≅ 𝟏𝟐. 𝟏𝟕%
60
𝑊𝐴𝐴𝐶 = 𝑊𝑒 ∗ 𝑟𝑒 + 𝑊𝑑 ∗ 𝑟𝑑(1 − 𝑡𝑐) + 𝑊𝑝 ∗ 𝑟𝑝
𝑾𝑨𝑨𝑪 = 0,60(0,01217) + 0,25(0,20)(1 − 0,40) + 0,60(0,08)
𝑾𝑨𝑨𝑪 = 𝟎, 𝟎𝟖𝟓𝟑𝟎𝟐 ≅ 𝟖, 𝟓𝟑%