Hey Guys!, Inc. has debt with both a book and a market value of $3,000. This debt has a coupon rate of 7% and pays interest annually. The expected earnings before interest and taxes are $1,200,
The tax rate is 34%, and the unlevered cost of capital is 12%. What is the ﬁrm's cost of equity?
A) 13.25%
B) 13.89%
C) 13.92%
D) 14.14%
E) 14.25%

Question

Quizplus · Accepted Answer

The firm's 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). Here, the after-tax cost of debt is 7% * (1 - 0.34) = 4.62%. The equity value can be derived from the firm's earnings and debt, and using these values, the cost of equity is approximately 14.14%.