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Discussion- Suppose a start-up young company with all-equity financing has a cost of equity (rr E) of 13%. Now the company tries to refinance to the following market-value capital structure: Debt (D) ratio 40% and Equity (E) ratio 60%. The cost of debt (d) is 7%. The tax rate is 35%. Please answer the following two questions:
Problem 1: Calculate the new cost of equity rE and the after-tax weighted-average cost of capital (WACC).
Problem 2: Now suppose if the firm continues to issue additional 10$ debt to replace equity, what's the new rE and WACC? (assume the cost of debt rd increases from 7% to 7.8%, caused by larger debt ratio)
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