A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is considering a new capital structure with 50% debt. The interest rate on the debt would be 5%. Assuming that the corporate tax rate is 40%, and all else is equal. including its risk profile, what would be its new cost of equity?

Question

Business

Travis Shaffer

8 November, 04:57

A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is considering a new capital structure with 50% debt. The interest rate on the debt would be 5%. Assuming that the corporate tax rate is 40%, and all else is equal. including its risk profile, what would be its new cost of equity?

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Answers (2)

Know the Answer?

Kelsie White · Answer 1

Answer: 9.8%

Explanation:

Because rs = 8 + (1 -.4) (1) (8-5) = 8 + 1.8 = 9.8%

Jonathan Nunez · Answer 2

9.8%

Explanation:

Formula;

Ke=overall cost of capital + (1-.4) (Overall cost of capital-cost of debt)

Where Ke = Cost of equity

overall cost of capital=8%

cost of debt=5%

Ke=8% + (1-.4) * (8%-5%)

Ke=8% + (1.8%)

Ke=9.8%