Fin622 GDB No. 2 solution
Sunday, May 29, 2011 Posted In Fin Edit This
Semester “Spring 2011”
“Corporate Finance (Fin622)”
This is to inform that Graded Discussion Board (GDB # 02)
will be opened according to the following schedule
Schedule
Opening Date and Time
May 27, 2011 At 12:00 A.M. (Mid-Night)
Closing Date and Time
May 31, 2011 At 11:59 P.M. (Mid-Night)
Topic/Area for Discussion
“ Weighted Average Cost of Capital (WACC) ”
Note: The discussion question will be from the area/topic mentioned above. So start learning about the topic now.
GDB Question
Following data has been calculated for MKJ Company:
Cost of Debt = 9%
Cost of Equity = 11%
Tax Rate = 35%
The company is evaluating weighted average cost of capital (WACC) by considering different capital structures. You are required to calculate:
WACC if the debt-equity ratio of company is 0.5
WACC if the debt-equity ratio of company is 1.0
WACC if the debt-equity ratio of company is 2.0
What is the trend (increasing/decreasing/constant) of WACC with an increasing debt-equity ratio?
Solution:
WACC (when debt-equity ratio is 0.5) = 0.09
WACC (when debt-equity ratio is 1.0) = 0.06
WACC (when debt-equity ratio is 2.0) = 0.01
Trend of WACC with increasing D/E ratio = Decreasing
::::::::::::::::::::::::::::::::::
WACC if the Debt-equity Ratio of Company is .5
WACC=.11(1/1.5) .09(.5/1.5)(1-.35)
WACC=.11(.666666666) .09(.333333333)(.65)
WACC=.073333333 .03(.65)
WACC=.073333333 .0195
WACC=.092833333
WACC=9.28%
WACC if the Debt-equity Ratio of Company is 1.0
WACC=.11(1/2) .09(1/2)(1-.35)
WACC=.11(.5) .09(.5) (.65)
WACC=.055 ..045(.65)
WACC=.055 .02925
WACC=.08425
WACC=8.42%
WACC if the Debt-Equity Ratio of Company is 2.0
WACC=.11(1/3) .09(2/3)(1-.35)
WACC=.11(.333333333) .09(.666666666)(.65)
WACC=.036666666 .06(.65)
WACC=.036666666 .039
WACC=.075666666
WACC=7.56%
Trend of WACC with increasing D/E ratio = Decreasing
:::::::::::::::::::::::::::::::
WACC if the Debt-equity Ratio of Company is .5
WACC=.11(1/1.5) + .09(.5/1.5)(1-.35)
WACC=.11(.666666666) + .09(.333333333)(.65)
WACC=.073333333 + .03(.65)
WACC=.073333333 + .0195
WACC=.092833333
WACC=9.28%
WACC if the Debt-equity Ratio of Company is 1.0
WACC=.11(1/2) + .09(1/2)(1-.35)
WACC=.11(.5) + .09(.5) (.65)
WACC=.055 + ..045(.65)
WACC=.055+.02925
WACC=.08425
WACC=8.42%
WACC if the Debt-Equity Ratio of Company is 2.0
WACC=.11(1/3) + .09(2/3)(1-.35)
WACC=.11(.333333333) + .09(.666666666)(.65)
WACC=.036666666 + .06(.65)
WACC=.036666666 + .039
WACC=.075666666
WACC=7.56%
Trend of WACC With increasing D/E Ratio
Increase in Debt or Debt-equity Ratio decreases the WACC
::::::::::::::::::::::::::::::::::::::::
Trend of WACC with increasing D/E ratio = decreasing.
This means that as we increase the D/E ratio, WACC decreases as we see when we increase the ratio from 0.5 to 2,WACC decreases from 9.42 to 7.56. This happens due to tax advantage of increasing the amount of debt .
“Corporate Finance (Fin622)”
This is to inform that Graded Discussion Board (GDB # 02)
will be opened according to the following schedule
Schedule
Opening Date and Time
May 27, 2011 At 12:00 A.M. (Mid-Night)
Closing Date and Time
May 31, 2011 At 11:59 P.M. (Mid-Night)
Topic/Area for Discussion
“ Weighted Average Cost of Capital (WACC) ”
Note: The discussion question will be from the area/topic mentioned above. So start learning about the topic now.
GDB Question
Following data has been calculated for MKJ Company:
Cost of Debt = 9%
Cost of Equity = 11%
Tax Rate = 35%
The company is evaluating weighted average cost of capital (WACC) by considering different capital structures. You are required to calculate:
WACC if the debt-equity ratio of company is 0.5
WACC if the debt-equity ratio of company is 1.0
WACC if the debt-equity ratio of company is 2.0
What is the trend (increasing/decreasing/constant) of WACC with an increasing debt-equity ratio?
Solution:
WACC (when debt-equity ratio is 0.5) = 0.09
WACC (when debt-equity ratio is 1.0) = 0.06
WACC (when debt-equity ratio is 2.0) = 0.01
Trend of WACC with increasing D/E ratio = Decreasing
::::::::::::::::::::::::::::::::::
WACC if the Debt-equity Ratio of Company is .5
WACC=.11(1/1.5) .09(.5/1.5)(1-.35)
WACC=.11(.666666666) .09(.333333333)(.65)
WACC=.073333333 .03(.65)
WACC=.073333333 .0195
WACC=.092833333
WACC=9.28%
WACC if the Debt-equity Ratio of Company is 1.0
WACC=.11(1/2) .09(1/2)(1-.35)
WACC=.11(.5) .09(.5) (.65)
WACC=.055 ..045(.65)
WACC=.055 .02925
WACC=.08425
WACC=8.42%
WACC if the Debt-Equity Ratio of Company is 2.0
WACC=.11(1/3) .09(2/3)(1-.35)
WACC=.11(.333333333) .09(.666666666)(.65)
WACC=.036666666 .06(.65)
WACC=.036666666 .039
WACC=.075666666
WACC=7.56%
Trend of WACC with increasing D/E ratio = Decreasing
:::::::::::::::::::::::::::::::
WACC if the Debt-equity Ratio of Company is .5
WACC=.11(1/1.5) + .09(.5/1.5)(1-.35)
WACC=.11(.666666666) + .09(.333333333)(.65)
WACC=.073333333 + .03(.65)
WACC=.073333333 + .0195
WACC=.092833333
WACC=9.28%
WACC if the Debt-equity Ratio of Company is 1.0
WACC=.11(1/2) + .09(1/2)(1-.35)
WACC=.11(.5) + .09(.5) (.65)
WACC=.055 + ..045(.65)
WACC=.055+.02925
WACC=.08425
WACC=8.42%
WACC if the Debt-Equity Ratio of Company is 2.0
WACC=.11(1/3) + .09(2/3)(1-.35)
WACC=.11(.333333333) + .09(.666666666)(.65)
WACC=.036666666 + .06(.65)
WACC=.036666666 + .039
WACC=.075666666
WACC=7.56%
Trend of WACC With increasing D/E Ratio
Increase in Debt or Debt-equity Ratio decreases the WACC
::::::::::::::::::::::::::::::::::::::::
Trend of WACC with increasing D/E ratio = decreasing.
This means that as we increase the D/E ratio, WACC decreases as we see when we increase the ratio from 0.5 to 2,WACC decreases from 9.42 to 7.56. This happens due to tax advantage of increasing the amount of debt .
