Question 1

Weston Industries has a debt-to-equity ratio of 1.5. Its WACC is 11 percent and its cost of debt is 8 percent. The corporate tax rate is 35 percent. Using the MM Proposition 2 with tax (Case 2), compute the following values.

Required:

a. What is Weston's cost of equity capital?

b. What is Weston's unlevered cost of equity capital?

c. What would the cost of equity and the corresponding WACC be if the debt-to-equity

ratio were 2? What if it were 1.0? What if it were zero?

d. Given these three debt-to-equity ratio, which one will result in the highest firm-value?

Question 2

Young Corporation expects an EBIT of $16,000 every year forever. The company currently has no debt, and its cost of equity if 15 percent. The corporate tax rate is 35 percent. Using the MM Proposition 1 with tax (Case 2), compute the following values.

Required:

a. What is the current value of the company?

b. Suppose the company can borrow at 10 percent. What will the value of the firm be if the company takes on debt equal to 50 percent of its unlevered value? What if it takes on debt equal to 100 percent of its unlevered value?