Question

An all-equity firm has a return on assets of 15.3 percent. The firm is considering converting to a debt-equity ratio of 0.30. The pre-tax cost of debt is 8.1 percent. Ignoring taxes, what will the cost of equity be if the firm switches to the leveraged capital structure

Answer 1

Answer:

re 17.4600%

Explanation:

We will calculate using the Modigliani Miller proposition with no taxes to solve for the cost of equity of a levered firm

$r_e = r_u + (r_r - r_b) \frac{B}{S}\\where:\\r_e= cost of equity\\r_b= cost of debt\\r_u= return on assets\\B/S = Debt to Equity$

We plus our values into the formula and solve

$r_e = 0.153+ (0.153 - 0.081)0.3$

re 17.4600%