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How cost of equity in different countries are calculated?
Solution
The solution is as follows −
Country 1: No taxes
a) Debt to equity ratio is Zero
Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)
Cost of equity = 15% + (15% - 5%) * 0 => 10%
b) Debt to equity ratio is 1
Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)
Cost of equity = 15% + (15% – 5%) * 1
Cost of equity = 10% + 5% => 20%
c) Debt to equity ratio is 2
Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)
Cost of equity = 15% + (15% – 5%) * 2
Cost of equity = 15% + 10% => 25%
- Country 2: corporate tax
a) Debt to equity ratio is Zero
Cost of equity = WACC + (WACC – Cost of debt) *(1-corporate tax) * (debt/equity)
Cost of equity = 15% + (15% - 5%) *(1-32%) * 0 =>15%
b) Debt to equity ratio is 1
Cost of equity = WACC + (WACC – Cost of debt) *(1-corporate tax) * (debt/equity)
Cost of equity = 15% + (15% – 5%) *(1-32%) * 1=> 21.8%
c) Debt to equity ratio is 2
Cost of equity = WACC + (WACC – Cost of debt) * (1-corporate tax) * (debt/equity)
Cost of equity = 15% + (15% – 5%) * (1-32%) * 2=> 28.6%
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