Question

Eccles Inc.

Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.

Refer to the data for Eccles Inc.What is the firm's cost of equity according to MM with corporate taxes?

	a.	23.3%
	b.	32.0%
	c.	25.9%
	d.	21.0%
	e.	28.8%

Answer 1

Value of Unlevered = EBIT*(1-Tax Rate)/Cost of Unlevered Equity = 100,000*(1-30%)/16% = 70,000/0.16 = 4,375,000
Value Levered = Value Unlevered + Debt*Tax rate = 4,375,000 +500000*0.3 = 587,500
Value of Equity = 587,500 -500000 = 87,500


Cost of Levered Equity = Cost of Unlevered Equity +(Cost of Unlevered Equity- Cost of Debt)* Debt*(1-Tax Rate)/ Equity
16% + (16%-12%)((500000*(1-30%)/*87,500) = 25.9%

Please Discuss in case of Doubt

Best of Luck. God Bless
Please Rate Well