Question

The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what would Firm L's total value be if it had no debt?

Answer 1

Answer:

14%

Explanation:

As we know that:

Firm's Cost of Equity = Ke + (Ke - Kd) * Market Value of Debt / Market Value of Equity

Here

Ke is 12%

Kd is 9%

MV of Debt is $200,000

MV of Equity is $300,000

By putting values, we have:

Firm's Cost of Equity = 12%  - (12% - 9%) * $200,000 / $300,000

Firm's Cost of Equity = 14%