Horford Co. has no debt. Its cost of capital is 8.9 percent. Suppose the company

converts to a debt-equity ratio of 1.0. The interest rate on the debt is 5.7 percent. Ignore

taxes for this problem.

a. What is the company's new cost of equity? (Do not round intermediate calculations

and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b. What is its new WACC? (Do not round intermediate calculations and enter your

answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Question

Answered

Answer :

Abiolataiwo2015go Abiolataiwo2015go · Answer 1

Answer:

A. 12.1%

B. 8.9%

Explanation:

a. Calculation for What is the company's new cost of equity

Using this formula

New cost of equity=Cost of capital+[(Cost of capital- Debt interest rate ) *(Debt-equity ratio)*(1)]

Let plug in the formula

New cost of equity=[0.089+[(0.089-0.057)*(1)*1]

New cost of equity=[0.089+0.032*(1)*1]

New cost of equity=[0.121*(1)*1]

New cost of equity=0.121*100

New cost of equity=12.1%

Therefore the company's new cost of equity will be 12.1%

b. Calculation for What is its new WACC

Particular Weight Cost Weighted cost

Equity 0.5000 *12.1% = 0.0605

Debt 0.5000 * 5.7% =0.0285

WACC =0.089*100

WACC =8.9%

(0.0605+0.0285)

Therefore the new WACC will be 8.9%