Deitweiler International has an unlevered cost of capital of 10%, a tax rate of 35%, and expected earnings before interest and taxes of $26,500. The company has $40,000 in bonds outstanding
That have a 7% coupon and pay interest annually. The bonds are selling at par value. What is the
Cost of equity?

Question

Quizplus · Accepted Answer

The cost of equity can be calculated using the Modigliani-Miller Proposition II with taxes: Cost of Equity = Unlevered Cost of Capital + (Unlevered Cost of Capital - After-tax Cost of Debt) * (Debt/Equity). The after-tax cost of debt is 7% * (1 - 0.35) = 4.55%. The equity value can be calculated as the difference between the firm's value and the debt. Using these values, the cost of equity is approximately 10.53%.

Deitweiler International Has an Unlevered Cost of Capital of 10