A ﬁrm is worth $1,400, has a 35% tax rate, total debt of $600, an unlevered return of 15%, and a cost of debt of 9%. What is the cost of equity?

Question

Quizplus · Accepted Answer

First, we need to calculate the value of the firm after accounting for debt. This is known as the unlevered value of the firm:

Unlevered value = value of the firm with no debt = $1,400 - $600 = $800

Next, we can use the following formula to calculate the cost of equity:

Cost of equity = Unlevered return + (Unlevered return - Cost of debt) x (1 - Tax rate)

Cost of equity = 15% + (15% - 9%) x (1 - 0.35)
Cost of equity = 17.93%

Therefore, the answer is C.

A ﬁRm Is Worth $1,400, Has a 35% Tax Rate