A firm has a debt-equity ratio of .64,a cost of equity of 13.04 percent,and a cost of debt of 8 percent.Assume the corporate tax rate is 25 percent.What would be the cost of equity if the firm were all-equity financed?
A)11.30 percent
B)11.41 percent
C)13.33 percent
D)12.42 percent
E)12.25 percent

Question

Quizplus · Accepted Answer

The cost of equity for an all-equity financed firm is calculated using the Modigliani-Miller Proposition II without taxes, which states that the cost of equity is equal to the cost of capital for an unlevered firm. The formula is: Cost of Equity = Cost of Equity (levered) - (Debt/Equity) * (Cost of Equity (levered) - Cost of Debt) * (1 - Tax Rate). Plugging in the values: 13.04% - 0.64 * (13.04% - 8%) * (1 - 0.25) = 11.41%.

A Firm Has a Debt-Equity Ratio of