Chelsea Corporation's cost of equity is 16% and it is 100% equity financed.If it can borrow enough money at 10% to buy back half of its stock,what would would happen to the cost of equity be under the original assumptions of the Modigliani and Miller Capital Structure Theorem.

Question

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According to the Modigliani and Miller theorem, when a firm takes on debt, the cost of equity increases because equity holders demand a higher return for the increased risk. The cost of equity would rise to 22% as the firm becomes leveraged.

Chelsea Corporation's Cost of Equity Is 16% and It Is