Question

Donner Metals has a cost of equity of 14.1 percent and a pretax cost of debt of 7.82 percent. The debt-equity ratio is 1.40 and the tax rate is 25 percent. What is the unlevered cost of capital?

		10.68%
		10.88%
		11.04%
		11.27%
		11.43%

Answer 1

Cost of levered equity = Cost of unlevered equity + (Cost of unlevered equity - cost of debt)(1 - tax)debt-debt ratio

0.141 = Cost of unlevered equity + (Cost of unlevered equity - 0.0782)(1 - 0.25)1.4

0.141 = Cost of unlevered equity + (Cost of unlevered equity - 0.0782)1.05

0.141 = Cost of unlevered equity + 1.05Cost of unlevered equity - 0.08211

0.22311 = 2.05Cost of unlevered equity

Cost of unlevered equity = 0.1088 or 10.88%