A firm has a debt-to-equity ratio of 1.If it had no debt, its cost of equity would be 12 percent.Its cost of debt is 9 percent.What is its cost of equity if there are no taxes?
A)21 percent
B)18 percent
C)15 percent
D)16 percent

Question

Quizplus · Accepted Answer

The cost of equity can be calculated using the Modigliani-Miller Proposition II (no taxes), which states that the cost of equity increases with leverage. The formula is: Cost of Equity = Cost of Equity (unlevered) + (Debt/Equity) * (Cost of Equity (unlevered) - Cost of Debt). Here, Cost of Equity (unlevered) = 12%, Debt/Equity = 1, and Cost of Debt = 9%. So, Cost of Equity = 12% + 1 * (12% - 9%) = 15%.

A Firm Has a Debt-To-Equity Ratio of 1