Question

1. Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

   		10.89 percent
   		11.47 percent
   		11.70 percent
   		13.97 percent

Answer 1

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

0.145 = Cost of uneleverd equity + (cost of unlevered equity -0.049)0.8

0.145 = Cost of uneleverd equity + 0.8cost of unlevered equity - 0.0392

0.1842 = 1.8Cost of uneleverd equity

Cost of uneleverd equity = 0.102333 or 10.23333%

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

Cost of levered equity = 0.102333 + (0.102333 - 0.049)0.7

Cost of levered equity = 0.102333 + 0.03733

Cost of levered equity = 0.1397 or 13.97%

Therefore, new cost of equity will be 13.97%