Gerrard Corp has no debt and can borrow at 7%. The firm's WACC is currently 13% and the tax rate
is 38 percent.
a) What is Gerrard Corp's cost of equity? (1 Mark) 13%
b) If the firm converts to 25 percent debt, what will be the cost of equity? (3 Marks) 14.24%
c) After your restructuring in b) - will the new WACC be greater or less than 13%? Prove with a
calculation. 11.77%

Common Stock: 200,000 shares outstanding, Price = $62 per share. The beta is 1.04
Bonds: 9000 6.5 percent bonds outstanding, $1,000 face value for each bond,
Selling for 93 percent of par, bonds make semi-annual payments and have 20
years to maturity.
Preferred Stock 14,000 shares of 6 percent preferred stock outstanding, currently selling for
$78 per share
Tax rate: 34%
Market Data: Market risk premium is 7%. T-Bill rate is 3.5%.
Using the information found in the table above, calculate the following:
a) Calculate the capital structure weights.
CS 12,400,000 56.7%
Bonds 8,370,000 38.3%
Pref's 1,092,000 5%
b) Calculate the cost of debt. 4.73%
c) Calculate the cost of equity. 10.78%
d) Calculate the cost of preferred stock. 7.69%
e) Calculate the Weighted Average Cost of Capital 8.3%

Martha's Grapevines, Inc. has an EBIT of $65,000 forever, no debt, a 35% tax rate, and its
cost of equity is 14% cost of capital. It can borrow at 7%.
a) What is the value of the firm? (2 marks)
b) What will the value of the firm be if Martha's Grapevines issues $95,000 in debt and uses
the proceeds to repurchase shares?

Potter Inc. is comparing two different capital structures: an all-equity plan (Plan I) and a
levered plan (Plan II). Under Plan I, the company would have 180,000 shares of stock
outstanding. Under Plan II, there would be 120,000 shares of stock outstanding and
$1,600,000 in debt outstanding. The interest rate on the debt is 7 percent, and there are no
taxes.
a) If EBIT is $300,000, which plan will result in the higher EPS?
Plan 1: $1.67 Plan II: $1.57
b) If EBIT is $500,000, which plan will result in the higher EPS?
Plan 1: $2.78 Plan II: $3.23
c) What is the break-even EBIT?

Kuhlmann Corp. has no debt but can borrow at 6.8 percent. The firm's WACC is currently 8.5
percent, and the tax rate is 35 percent.
a) What is the company's cost of equity?
b) If the firm converts to 20 percent debt, what will its cost of equity be?
c) If the firm converts to 45 percent debt, what will its cost of equity be?
d) What is the company's WACC in part (b)? In part (c)?

Answer rating: 100% (QA)

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