Answer:
Expected rate of return on equity under the new capital structure is 9.75 %
Explanation:
given data
Market value of long-term debt = $20,888 million
Market value of common stock = $171,138 million
Beta = 1.04
Yield to maturity at 10 year t = 2.167%
Expected return on equity = 8.895%
Marginal tax rate t = 35%
solution
we get here cost of unlevered equity by the cost of levered equity formula that is
cost of levered equity = rSU + (rSU-rD) × (1-t) × (D÷S) .................1
here rSL is cost of levered equity and rSU is cost of unlevered equity and rD is before tax cost of debt and D is value of debt and S is value of equity.
put here value and we will get
8.895% = rSU + (rSU-2.167%) × (1-35%) × (20,888÷171,138)
solve it we get
rSU = 0.084005
cost of unlevered equity = 8.40 %
and
cost of levered equity for new capital structure will be
put here value in equation 1
cost of levered equity = 8.40 + (8.40-2.376%) × (1-35%) × ( 20 ÷ 80 )
cost of levered equity = 9.75 %
