Boob-Tube Electronics Inc.has long term bonds with a face value of $2M,the coupon rate on the bonds is 5% and the yield on the bonds is also 5%.The unlevered cost of equity is 12.5%,and the value of Boob-Tube's equity is $3.6M.The corporate tax rate is 40%.What is the required return of shareholders at Boob-Tube?

Question

Quizplus · Accepted Answer

This solution uses Modigliani & Miller Proposition II with taxes: k_E = k_U + (k_U - k_D) × (1 - T) 11ea7fdb_fc67_87e0_a768_7b014ece11b1_TB2902_11 k_E = 0.125 + (0.125 - 0.05) x (1 - 0.40) × 11ea7fdb_fc67_87e1_a768_871378ba3c86_TB2902_11 = 0.15 or 15%