Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital of 10%.Taggart is considering borrowing funds at a cost of 6% and using these funds to repurchase existing shares of stock.Assume perfect capital markets.If Taggart borrows until they achieved a debt-to-value ratio of 20%,then Taggart's levered cost of equity would be closest to:
A)8.0%.
B)9.2%.
C)10.0%.
D)11.0%.

Question

Quizplus · Accepted Answer

In perfect capital markets, the levered cost of equity can be calculated using the formula: Levered Cost of Equity = Unlevered Cost of Equity + (Debt/Equity) * (Unlevered Cost of Equity - Cost of Debt). With a debt-to-value ratio of 20%, the equity-to-value ratio is 80%. Therefore, Debt/Equity = 0.25. Plugging in the values: 10% + 0.25 * (10% - 6%) = 11%.

Suppose That Taggart Transcontinental Currently Has No Debt and Has