The Marble Paving Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5 and a cost of debt is 11%. What is the cost of equity if the firm was unlevered? (Assume a tax rate of 33%)

Question

Quizplus · Accepted Answer

The cost of equity for an unlevered firm can be calculated using the Modigliani-Miller theorem. The formula is: Cost of Equity (Unlevered) = Cost of Equity (Levered) - (Debt/Equity) * (Cost of Equity (Levered) - Cost of Debt) * (1 - Tax Rate). Plugging in the values: 17% - 1.5 * (17% - 11%) * (1 - 0.33) = 14%.