Lizzie's Kitchen has a debt-equity ratio of.60. The firm's required return on assets is 11% and its cost of equity is 14.7%. What is the pre-tax cost of debt based on M&M II with no taxes?

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Quizplus · Accepted Answer

According to Modigliani and Miller Proposition II (without taxes), the cost of equity is equal to the required return on assets plus the debt-equity ratio times the difference between the required return on assets and the pre-tax cost of debt. Solving for the pre-tax cost of debt: 14.7% = 11% + 0.60 * (11% - pre-tax cost of debt), which gives a pre-tax cost of debt of 4.83%.

Lizzie's Kitchen Has a Debt-Equity Ratio Of