CASE 2 (25 points)

A corporation has a weighted average cost of capital (ignoring taxes) of 12 percent. It can borrow at 8 percent.

Instructions:

Answer the following questions. Show your solutions.

1) Assuming that the company has a target capital structure of 80 percent equity and 20 percent debt, what is its cost of equity? Ignore taxes. (10 points)

2) What is the cost of equity if the target capital structure is 50 percent equity? Ignore taxes. (10 points)

3) Calculate the WACC using your answers to (1) and (2) to verify that it stays the same. (5 points)