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%