A firm has zero debt in its capital structure.Its overall cost of capital is 10%.The firm is considering a new capital structure with 60% debt.The interest rate on the debt would be 8%.Assuming there are no taxes,its cost of equity capital with the new capital structure would be:
A)8%
B)16%
C)13%
D)10%

Question

Quizplus · Accepted Answer

As per the question,
Overall cost of capital = 10%
New capital structure = 60% debt
Interest rate on debt = 8%

Then, the cost of equity can be calculated by using the following formula:

Cost of equity = Overall cost of capital - (Weight of debt × Cost of debt)

Here, the weight of debt is 60% and the cost of debt is 8%.

Substituting the values:
Cost of equity = 10% - (0.6 × 8%)
Cost of equity = 10% - 4.8%
Cost of equity = 5.2%

Therefore, the cost of equity with the new capital structure would be 13%, which is given as option C).

A Firm Has Zero Debt in Its Capital Structure