Prescription Express has a debt-equity ratio of.70. The pre-tax cost of debt is 8.5% while the unlevered cost of capital is 15%. What is the cost of equity if the tax rate is 35%?
A) 13.79%
B) 14.28%
C) 17.96%
D) 18.40%
E) 18.87%

Question

Quizplus · Accepted Answer

The cost of equity (Re) can be calculated using the Modigliani-Miller Proposition II with taxes, which states that Re = Ru + (Ru - Rd)(1 - Tc)(D/E), where Ru is the unlevered cost of capital, Rd is the pre-tax cost of debt, Tc is the corporate tax rate, and D/E is the debt-to-equity ratio.Given:- Ru = 15%- Rd = 8.5%- Tc = 35%- D/E = 0.70Re = 15% + (15% - 8.5%)(1 - 0.35)(0.70) = 15% + (6.5%)(0.65)(0.70) = 15% + 2.96% = 17.96%

Prescription Express Has a Debt-Equity Ratio Of