Question

APM Inc. is in the property management business and has a required return on its assets of​ 14%. It can borrow in the debt market at​ 7%. If there are no taxes and​ M&M's proposition II​ holds, what is the cost of equity if there is​ 30% equity financing and​ 70% debt​ financing?

A. ​21.0%

B. ​30.3%

C. ​7.0%

D. ​39.7%

E. ​17.0%

Answer 1

The cost of equity is computed as shown below:

WACC is computed as follows:

WACC = After tax cost of debt x weight of Debt + cost of equity x weight of equity

Let cost of equity x weight of equity be Y

0.14 = 0.07 x 0.70 + Y

Y = 14% - 4.9%

Y = 9.1%

So, the cost of equity will be computed as follows:

Y = cost of equity x weight of equity

9.1 % = cost of equity x 0.30

cost of equity = 30.3% Approximately

So, the correct answer is option B.

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