Question

Gamesys has a cost of equity of 12.84 percent and a pretax cost of debt of 6.7 percent. The debt-equity ratio is 1.40 and the tax rate is 25 percent. What is the company's unlevered cost of capital?

		9.03%
		9.28%
		9.46%
		9.59%
		9.70%

Answer 1

Answer:- Correct answer is 9.70%

Working

Pre Tax cost of Debt = 6.7%

Tax Rate = 25%

Therefore , Post tax Cost of Debt = 6.7% *(1-25%)

Post tax Cost of Debt = 5.025%

Cost of Equity = 12.84%

Levered cost of Captital = Cost of Debt* Debt equity ratio + Cost of Equity

= 5.025% *1.40 + 12.84%  

= 7.035% + 12.84%

= 19.875%

Leavered Cost of Capital = Unlevered Cost of Captal [1+(1-Tax)*Debt / Equity ]

19.875% = Unlevered cost of Capital * [1+(1-25%)*1.40]

19.875% = Unlevered Cost of Capital * [1+1.05]

Unlevered Cost of Capital = 19.875% / 2.05 = 9.70%