Malkin corp. has no debt but can borrow at 8.75 percent. the firm’s wacc is currently 16 percent, and there is no corporate tax. required: (a what is malkin’s cost of equity?% (b if the firm converts to 15 percent debt, what will its cost of equity be?% (c if the firm converts to 50 percent debt, what will its cost of equity be?% (d what is malkin’s wacc in part (b and (c?

A) 16%

B) 17.28%%

C) 23.25%

D) debt = 15%, WACC ⇒ 16%

debt = 50%, WACC ⇒ 16%

Explanation:

WACC = weighted average cost of capital is the rate at which the company effectively finances its assets.

The formula used to calculate WACC is:

WACC = {[total equity/(total debt + equity)] x cost of equity} +  {[total debt/(total debt + equity)] x cost of debt x (1 - tax rate)}

A) equity = 100%

WACC = cost of equity = 16%

B) Modigliani-Miller proposition II, changes the cost of equity once debt increases using the following formula

= old cost of equity + [(old cost of equity - cost of debt)x(debt/equity)x(1 - taxes)]

equity = 85%, debt = 15%

cost of equity = 16% + [(16% - 8.75)x(0.15/0.85)] = 16% + 1.28% = 17.28%

C) equity = 50%, debt = 50%

cost of equity = 16% + [(16% - 8.75)x(.5/.5)] = 16% + 7.25% = 23.25%

D) Since there are no corporate taxes, the WACC will not decrease by taking debt.

equity = 85%, debt = 15%

WACC = (0.85 x 17.28%) + (.15 x 8.75%) = 14.69% + 1.31% = 16%

equity = 85%, debt = 15%

WACC = (0.50 x 23.25%) + (.5 x 8.75%) = 11.625% + 4.375% = 16%

answer; yield to maturity;

riley- $3

sean- $4

jake- $8

riley has the absolute advantage.