Question

Big show inc. worth $1,400 has a 35percent tax rate, total debt of$600, an unleavened return of 15petcent and a cost of debt of 9 percent. Calculate BigShow’s cost of equity?

Answer 1

Solution:
	BigShow’s cost of equity is 17.93%
Working Notes:
	To get BigShow’s cost of equity we will use M&M Proposition II formula.
	RE= RU+ (RU– RD)(D/E)(1 – tC)
	RE = Cost of equity = ??
	RU = unlevered return = 15%
	RD = Cost of debt = 9%
	D/E = Debt Equity ratio = Debt/(Worth - Debt )
	D/E = 600/(1400 - 600) = 600/800
	TC = Tax rate = 35%
	RE= RU+ (RU– RD)(D/E)(1 – tC)
	= 15% + (15% - 9%)(600/800) (1-0.35)
	= 15% + 6% x 0.75 x 0.65
	=15% + 2.925%
	=17.925 %
	=17.93%
Please feel free to ask if anything about above solution in comment section of the question.