A firm has a market value of assets of $50,000. It borrows $10,000 at 7%. If the unlevered cost of equity is 15%, what is the firm's cost of equity capital?

Question

Quizplus · Accepted Answer

To calculate the cost of equity capital, we need to use the formula:

cost of equity = unlevered cost of equity + (debt/equity) x (levered cost of equity - unlevered cost of equity)

First, we need to calculate the debt/equity ratio:

debt/equity = debt / (market value of assets - debt)
debt/equity = 10,000 / (50,000 - 10,000)
debt/equity = 0.25

Now we can plug in the values and solve for the cost of equity:

cost of equity = 15% + 0.25 x (15% - 7%)
cost of equity = 15% + 0.25 x 8%
cost of equity = 17%

Therefore, the answer is C) 17%.

A Firm Has a Market Value of Assets of $50,000