Question

An unlevered firm has a cost of capital of 12.46 percent and a tax rate of...

An unlevered firm has a cost of capital of 12.46 percent and a tax rate of 35 percent. The firm is considering a new capital structure with 35 percent debt. The interest rate on the debt would be 6.68 percent. What would be the firm's levered cost of capital?

Multiple Choice

14.48%

14.78%

13.90%

14.27%

13.94%

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Answer #1

As per MM Proposition II, Levered Cost of capital can be computed as -

where, Ke = Cost of capital, Kd = cost of debt or interest on debt, T = tax rate, D/E = Debt to equity ratio

If total capital is 1 and debt is 35% or 0.35, then Equity will be 0.65 (1 - 0.35).

% or 14.48%

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