Exley's Farms has a debt-equity ratio of .75. The cost of equity is 15% and the after-tax cost of debt is 5.4%. What will the ﬁrm's cost of equity be if the debt-equity ratio is revised to .60?

Question

Quizplus · Accepted Answer

The cost of equity can be recalculated using the Modigliani-Miller Proposition II with taxes, which shows that the cost of equity is a function of the firm's debt-equity ratio. With a lower debt-equity ratio, the cost of equity will decrease, but not proportionally. The correct recalculated cost of equity is 14.18%.

Exley's Farms Has a Debt-Equity Ratio of