Suppose that a company (XYZ) has a market value of $100 million. XYZ is funded entirely through equity and has an equity beta of 1.5. 

Assume:

- a market risk premium of 5%;

- a risk-free rate of 4%; and

- that the current tax rate is 0% (i.e., there are no taxes).

A) What is XYZ's cost of equity before raising debt? (Please show working)

Submit your answer with two decimals

Cost of equity: _______

B) What is XYZ's ra (cost of unleveraged assets) before raising debt? (Please show working)

Cost of unleveraged assets: _______

DEBT AND DIVIDENDS

Now suppose that the company plans to raise $50 million of debt and pay it as a

special dividend to shareholders. The company's debt will carry a premium of 50

basis points above the risk-free rate.

C) What is the company's D/E ratio after the debt issuance and dividend

payout? (Please show working)

D/E ratio:______

D) What is XYZ's cost of debt? (Please show working)

Cost of debt: _______

E) What is XYZ's new cost of equity after raising debt? (Please show working)

Cost of equity: _______

F) What is the company's E / (D + E) ratio? (Please show working)

E / (D + E) ratio: _______

ADD TAXES TO THE EQUATION

Assume XYZ will now have to pay 40% in corporate taxes.

H) What is XYZ's new cost of equity after raising debt, paying dividends, and in the presence of taxes? (Please show working)

Cost of equity: ________

I) What is the company's new WACC? (Please show working)

WACC: ________

Answer rating: 100% (QA)

A Cost of equity before raising debt The cost of equity can be calculated using the Capital Asset Pricing Model CAPM Cost of Equity RiskFree Rate Beta Market Risk Premium Given Riskfree rate 4 Equity ... View the full answer