A firm has a debt-equity ratio of 1,a cost of equity of 16 percent,and a cost of debt of 8 percent.If there are no taxes or other imperfections,what is its unlevered cost of equity?
A)8 percent
B)10 percent
C)12 percent
D)14 percent
E)16 percent

Question

Quizplus · Accepted Answer

The unlevered cost of equity can be calculated using the Modigliani-Miller Proposition II (no taxes), which states that the cost of equity is equal to the unlevered cost of equity plus the debt-equity ratio times the difference between the unlevered cost of equity and the cost of debt. Given the debt-equity ratio of 1, cost of equity of 16%, and cost of debt of 8%, the unlevered cost of equity is 12%.

A Firm Has a Debt-Equity Ratio of 1,a Cost of Equity