A firm is unlevered and has a cost of equity capital of 9 percent.What is the cost of equity if the firm becomes levered at a debt-equity ratio of 2? The expected cost of debt is 7 percent.(Assume no taxes.)

Question

Quizplus · Accepted Answer

The cost of equity for a levered firm can be calculated using the Modigliani-Miller Proposition II (no taxes): Cost of Equity = Cost of Unlevered Equity + (Debt/Equity) * (Cost of Unlevered Equity - Cost of Debt). Plugging in the values: 9% + 2 * (9% - 7%) = 13%.

A Firm Is Unlevered and Has a Cost of Equity