Question

Luther Industries has 25 million shares outstanding trading at $18 per share. In addition, Luther has $150 million in outstanding debt. Suppose Luther's equity cost of capital is 13%, its debt cost of capital is 7%, and the corporate tax rate is 40%. Luther's unlevered cost of capital is closest to:_______A) 11.5%B) 10.8%C) 9.8%D) 13.0%

Answer 1

Answer:

B. 10.8%

Explanation:

To get the Market value of equity = 25m x $18 = $450 million

The Market value of debt is given to be = $150 million

To get the weight of equity= 450/600

To get the weight of debt = 150/600

we have Ke as cost of equity= 13%

Such that after tax cost of debt = 7%(1-0.40) = 4.2%

Then the Weighted average cost of capital = We(Ke) + Wd(Kd)

= 450/600 x 13% + 150/600 x 4.2%

This gives us

= 9.75% + 1.05%

Therefore the answer is

= 10.80%

So the option B is correct