Question

AirCNC has a cost of equity of 12.2 percent and a pretax cost of debt of 8.44 percent. The debt-equity ratio is .80 and the tax rate is 25 percent. What is the unlevered cost of capital? 10.79% 10.38% 9.97% 9.63% 9.39%

Answer 1

Cost of levered equity = Cost of unlevered equity + (Cost of unlevered equity - cost of debt)(1 - tax)debt equity ratio

0.122 = Cost of unlevered equity + (Cost of unlevered equity - 0.0844)(1 - 0.25)0.8

0.122 = Cost of unlevered equity + (Cost of unlevered equity - 0.0844)0.6

0.122 = Cost of unlevered equity + 0.6Cost of unlevered equity - 0.05064

0.122 = 1.6Cost of unlevered equity - 0.05064

0.17264 = 1.6Cost of unlevered equity

Cost of unlevered equity = 0.1079 or 10.79%