FIN622 GDB Solution

Semester “Spring 2011”
“Corporate Finance (Fin622)” This is to inform you that Graded Discussion Board (GDB#02) has been opened according to the following schedule
Schedule
Opening Date and Time	May 27, 2011 AT 12:00 AM (Mid night)
Closing Date and Time	May 31, 2011 AT 11:59 PM (Mid night)
Note: No extra or bonus/grace period is available for attempting GBD.
The GDB will remain open for "120" hours 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? IMPORATANT NOTE: You are required to provide answers in percentage terms rounded to two decimal places e.g. 0.00%. Only accurate answers will be graded whereas rounded figures will not be awarded any marks. Furthermore, you are not required to show working and provide only answers in the following manner: WACC (when debt-equity ratio is 0.5)         =   ? WACC (when debt-equity ratio is 1.0)         =   ? WACC (when debt-equity ratio is 2.0)         =   ? Trend of WACC with increasing D/E ratio  =   ?
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SOLUTION:

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