The required return on equity for an all-equity firm is 10.0 percent.They are considering a change in capital structure to a debt-to-equity ratio of 1/2,the tax rate is 40 percent,the pre-tax cost of debt is 8 percent.Find the new cost of capital if this firm changes capital structure.

Question

Quizplus · Accepted Answer

The new cost of capital can be calculated using the formula for the weighted average cost of capital (WACC): WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc). With a debt-to-equity ratio of 1/2, E/V = 2/3 and D/V = 1/3. Substituting the given values: WACC = (2/3) * 10% + (1/3) * 8% * (1 - 0.4) = 8.67%.

The Required Return on Equity for an All-Equity Firm Is