Question

An all-equity firm has a return on assets of 21 percent. The firm is considering converting to a debt-equity ratio of .48. The pretax cost of debt is 6.9 percent. Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure? Please type out a type-by-step solution

A) 28.22 percent

B) 27.49 percent

C) 28.81 percent

D) 29.24 percent

E) 27.77 percent

Answer 1

Cost of equity: after recapitalisation Re = Ra +(Ra-Rd)(D/E)(1-1) Ra = unlevered cost of equity = 27.77% 0.21+((0.21-0.069)*(0.48)*1)