A firm has a market value of assets of $50,000.It borrows $10,000 at 7%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?
A)15%
B)16%
C)17%
D)18%
E)19%

Question

Quizplus · Accepted Answer

The formula to calculate the cost of equity capital of a levered firm is as follows:

Cost of Equity = Unlevered Cost of Equity + (Debt to Equity Ratio * (Unlevered Cost of Equity - After Tax Cost of Debt))

Here, 
Unlevered Cost of Equity = 15%
Debt to Equity Ratio = 10,000 / 50,000 = 0.2
After Tax Cost of Debt = (1- Tax Rate) * Interest Rate = (1- 0.21) * 7% = 5.53%

Substituting the values, we get:

Cost of Equity = 15% + (0.2 * (15% - 5.53%)) = 16.94% ≈ 17%

Therefore, the best choice is C, 17%.

A Firm Has a Market Value of Assets of $50,000