A firm has a debt-to-equity ratio of .60. Its cost of debt is 8%. Its overall cost of capital is 12%. What is its cost of equity if there are no taxes or other imperfections?
A) 10.0%
B) 13.5%
C) 14.4%
D) 18.0%
E) None of these.

Question

Quizplus · Accepted Answer

First, we need to calculate the firm's equity-to-debt ratio by subtracting the debt-to-equity ratio from 1:
Equity-to-debt ratio = 1 - 0.6 = 0.4

Next, we can use the formula for the weighted average cost of capital (WACC) to calculate the cost of equity:
WACC = (cost of equity x equity / total capital) + (cost of debt x debt / total capital)
12% = (cost of equity x 0.4) + (8% x 0.6)

Solving for the cost of equity, we get:
cost of equity = (12% - 8% x 0.6) / 0.4
cost of equity = 14.4%

Therefore, the best choice is C) 14.4%.

A Firm Has a Debt-To-Equity Ratio of