Winter's Toyland has a debt-equity ratio of .57. The pretax cost of debt is 8.2 percent and the required return on assets is 14.7 percent. What is the company's cost of equity if you ignore taxes?

Question

Quizplus · Accepted Answer

First, we need to find the debt and equity proportions in the capital structure. Given debt-equity ratio of .57, the debt proportion is 0.57/(1+0.57) = 0.36 and the equity proportion is 1 - 0.36 = 0.64.

Next, we can use the following formula to calculate the cost of equity:
Cost of Equity = Required Return on Assets - (Debt/Equity) x (Required Return on Assets - Pretax Cost of Debt)

Cost of Equity = 14.7% - 0.36 x (14.7% - 8.2%) 
Cost of Equity = 18.41%

Therefore, the answer is E.

Winter's Toyland Has a Debt-Equity Ratio of