Question

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. )

Answer 1

The company's new cost of equity is 12.1%. And The new WACC of that company is 8.9%

Cost of new equity generally can be defined as the price of a newly issued general stock that takes into account the flotation value of the new problem. Flotation value are the price incurred by the company in issuing the new stock.

To determine the new cost equity, it can be calculated by formula below:

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

From the scenario we know that

Cost of capital = 8.9% = 0.089

Debt interest rate = 5.7% = 0.057

Debt-equity ratio = 1

Thus, we add all of the value into formula, and it will be

New cost of equity = 0.089 + ( 0.089 - 0.057) x (1) x (1)

New cost of equity = 0.089 + 0.032 x 1

New cost of equity = 0.121 = 12.1%

The WACC formula is shown below:

Weighted average cost of capital (WACC)  = Weightage of Equity x Cost of equity

Weighted average cost of capital (WACC)  = Equity 0.5000 x 12.1% = 0.0605

Equity = 0.5000 x 5.7% =0.0285

Debt 0.5000 x 5.7% =0.0285

Weighted average cost of capital (WACC)  = 0.0605+0.0285

Weighted average cost of capital (WACC)  =0.089 x 100 = 8.9%

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