An unlevered firm has expected earnings of $37,584 and a market value of equity of $324,000.The firm is planning to issue $65,000 of debt at 6.6 percent interest and use the proceeds to repurchase shares at their current market value.Ignore taxes.What will be the cost of equity after the repurchase?
A)12.85%
B)13.58%
C)13.40%
D)12.04%
E)12.48%

Question

Quizplus · Accepted Answer

The cost of equity for an unlevered firm is calculated as the expected earnings divided by the market value of equity. After the firm issues debt and repurchases shares, the cost of equity increases due to the financial risk introduced by the debt. The new cost of equity can be calculated using the formula: Cost of Equity = (Earnings - Interest) / (Equity - Debt). Here, the interest is $65,000 * 6.6% = $4,290. The new equity value is $324,000 - $65,000 = $259,000. Thus, the cost of equity is ($37,584 - $4,290) / $259,000 = 12.85%.

An Unlevered Firm Has Expected Earnings of $37,584 and a Market