Alfa has market debt €1,200 and equity €800, debt return 4%, equity return 12.5% and corporate tax 30%. Apply MM II with corporate taxes.
- A.Find the unlevered cost of capital.
Cost of Equity and WACC
A.
8.15%
Cost of Equity and WACC
WD has equity cost 13.84%, debt €5,000, enterprise value €12,000, corporate tax 34% and unlevered capital cost 12%. Apply MM II with corporate taxes.
- A.Calculate the cost of debt.
A.
8.10%
Cost of Equity and WACC
- A.At the same D/E, operating risk and debt cost, how does corporate interest deductibility affect the equity return required on a levered firm?
A.
In the standard MM corporate-tax model, the leverage premium is multiplied by (1−T꜀). Therefore it is smaller than in the no-tax case, provided rᵤ exceeds rᴅ. This comparison holds other inputs fixed; it does not say that leverage itself lowers equity risk.
Cost of Equity and WACC
- A.With only corporate taxes, how does a moderate increase in debt affect rᴅ, rᴇ and WACC?
A.
If debt remains risk-free, rᴅ is unchanged. Equity becomes riskier and rᴇ rises. Under the standard permanent-debt MM assumptions, the interest tax shield raises firm value and lowers WACC. The conclusion depends on holding operating risk fixed and ignoring distress costs.
Cost of Equity and WACC
Gamma’s market asset value is €4,000, comprising debt €1,000 and equity €3,000. A separate accounting balance sheet reports different equity amounts.
- A.Which weights should enter WACC?
A.
25% debt and 75% equity.
Book-value equity is not the appropriate weight for this market-value cost of capital.
Cost of Equity and WACC
ABC has 80,000 bonds worth €1,000 each, debt yield 8.5%, four million shares priced at €40, equity beta 1.1, risk-free rate 4%, market risk premium 8% and corporate tax rate 35%.
- A.Calculate equity return, market-value weights and WACC.
A.
10.38%