The cost of capital for a ﬁrm, RWACC, in a zero tax environment is:
A)equal to the expected earnings divided by market value of the unlevered ﬁrm.
B)equal to the rate of return for that business risk class.
C)equal to the overall rate of return required on the levered ﬁrm.
D)is constant regardless of the amount of leverage.
E)All of the above.

Question

Quizplus · Accepted Answer

In a zero tax environment, the cost of capital for a firm (RWACC) is influenced by the business risk class and is not affected by the firm's leverage. It is equal to the expected earnings divided by the market value of the unlevered firm, reflects the overall rate of return required on the levered firm, and remains constant regardless of the amount of leverage. This is consistent with Modigliani and Miller's proposition I without taxes.

The Cost of Capital for a ﬁRm, RWACC, in a Zero