Final answer:
The levered cost of equity for KT Inc.'s new project is 15.25%, calculated using the Modigliani-Miller Proposition II with taxes. The company's weighted average cost of capital (WACC) for the project is determined to be 9.9%, based on the given debt to equity ratio of 1:1 and the other provided rates and tax information.
Step-by-step explanation:
KT Inc. is considering undertaking a new project and has determined that the un-levered cost of equity for the project is 12%, with a marginal tax rate of 35%, and a borrowing rate of 7%. With a debt to equity ratio of 1 for the project, we first calculate the levered cost of equity and then the weighted average cost of capital (WACC).
To start, let's calculate the levered cost of equity using the Modigliani-Miller Proposition II (with taxes). According to this formula:
Cost of Levered Equity (Re) = Cost of Unlevered Equity (Ru) + [Cost of Unlevered Equity (Ru) - Cost of Debt (Rd)] * (1 - Tax rate) * (Debt/Equity)
Given that Ru = 12%, Rd = 7%, Tax rate = 35%, and Debt/Equity = 1, we can plug these values into the equation:
Re = 12% + (12% - 7%) * (1 - 0.35) * 1
Re = 12% + 5% * 0.65
Re = 12% + 3.25%
Re = 15.25%
Now, to calculate WACC, we use the following formula:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tax rate)
Where E is the firm's equity, D is the firm's debt, V is the total value of the firm (E + D), Re is the levered cost of equity, Rd is the cost of debt, and the tax rate is the corporate tax rate.
Because the debt to equity ratio is 1:1, E/V and D/V both equal 0.5.
WACC = (0.5) * 15.25% + (0.5) * 7% * (1 - 0.35)
WACC = 0.07625 + 0.02275
WACC = 9.9%
The levered cost of equity for KT Inc.'s project is 15.25%, and the project's WACC is 9.9%.