Question

# Werner Company has debt with both a face and a market value of \$7,200,000. This debt...

Werner Company has debt with both a face and a market value of \$7,200,000. This debt has a coupon rate of 5.8 percent and pays interest annually. The expected earnings before interest and taxes are \$2,512,000, the tax rate is 25 percent, and the unlevered cost of capital is 10.4 percent. What is the firm's cost of equity? 13.04% 12.67% 11.93% 12.35% 11.76%

The debt has both face and market value of \$7,200,000. The I/Y(cost of debt )  will be 5.8%,

The unlevered cost if equity is 10.4%,

The value of firm is = EBIT(1 - TAX RATE)/ COST OF EQUITY

= \$2,512,000* 0.75/ .104

=\$18,115,384.6

Value of firm = \$18,115,384.6

Debt = \$7,200,000

EQUITY = \$10,915,384.6

D/E = \$7,200,000/ \$10,915,384.6

D/E = 0.659

Re = Ro + D/E ( Ro - Rd)(1 - tax rate), where Ro = unlevered cost of equity , Rd = cost of debt

=10.4+ 0.659 ( 10.4 - 5.8) (1 - 0.25)

= 12.67%

So, the correct option is option 2.

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