Question

vienna inc. currently has a capital structure that consists of 100% equity. the risk-free rate is 3%, and the market risk premium is 8%. the company's current cost of equity is 9%, and its tax rate is 30%. if vienna inc. were to change its capital structure to 30% debt and 70% equity, what would be the company's estimated cost of equity?

Answer 1

If Vienna Inc. changes its capital structure to 30% debt and 70% equity, its estimated cost of equity would be 8.6%.

Step-by-step explanation:

When a company changes its capital structure, it affects its cost of equity.

In this case, Vienna Inc. currently has a capital structure of 100% equity, but if it were to change to 30% debt and 70% equity, its estimated cost of equity would be different.

The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM), which takes into account the risk-free rate, the market risk premium, and the company's current cost of equity.

With the given information, the estimated cost of equity for Vienna Inc. would be:

Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium

Let's calculate the estimated cost of equity:

1. Cost of Equity = 3% + 0.7 * 8%
2. Cost of Equity = 3% + 5.6%
3. Cost of Equity = 8.6%

Therefore, if Vienna Inc. were to change its capital structure to 30% debt and 70% equity, its estimated cost of equity would be 8.6%.

Answer 2

To estimate the cost of equity after changing the capital structure, we can use the weighted average cost of capital (WACC) formula. The new cost of equity for Vienna Inc. would be approximately 7.92%.

Step-by-step explanation:

To estimate the cost of equity after changing the capital structure to 30% debt and 70% equity, we can use the weighted average cost of capital (WACC) formula.

WACC is the average rate of return a company expects to offer to its investors.

The formula for WACC is:

WACC = (weight of debt * cost of debt) + (weight of equity * cost of equity)

In this case, the company's current cost of equity is 9% and its cost of debt can be calculated using the risk-free rate and the market risk premium.

With the given information, the estimated cost of debt is:

Cost of debt = Risk-free rate + (Market risk premium * Tax rate)

= 3% + (8% * 30%)

= 3% + 2.4%

= 5.4%

Now, we can calculate the new cost of equity using the WACC formula:

New cost of equity = (0.7 * 9%) + (0.3 * 5.4%)

= 6.3% + 1.62%

= 7.92%