Johnson Tire Distributors has debt with both a face and a market value of $12,000.This debt has a coupon rate of 6 percent and pays interest annually.The expected earnings before interest and taxes are $2,100,the tax rate is 30 percent,and the unlevered cost of capital is 11.7 percent.What is the firm's cost of equity?
A)22.46 percent
B)22.87 percent
C)23.20 percent
D)23.59 percent
E)25.14 percent

Question

Quizplus · Accepted Answer

V_U = [$2,100 × (1 - 0.30)]/0.117 = $12,564.10V_L = $12,564.10 + (0.30 × $12,000) = $16,164.10V_E = $16,164.10 - $12,000 = $4,164.10R_E = 0.117 + [(0.117 - 0.06) × ($12,000/$4,164.10) × (1 - 0.30)] = 23.20 percent

Johnson Tire Distributors Has Debt with Both a Face and a Market