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Your firm has a debt-equity ratio of .75. The interest rate on the debt is 8.5%...

Your firm has a debt-equity ratio of .75. The interest rate on the debt is 8.5% and the unlevered cost of equity is 15%. What is the cost of equity if there are no taxes?

11.25%

19.88%

21.38%

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Answer #1

Let equity be " $ 1" ,Debt = 1*.75 = .75

Weight of Debt : .75/(1+.75)= .4286                               [Debt /(debt +equity)]

Weight of equity : 1/1.75 = .5714

Cost of levered firm is equal to cost of unlevered firm 15%

Cost of levered firm =[COSt of debt *weight of debt] +[cost of equity *weight of equity]

15 =[8.5*.4286]+ [COE *.5714]

15 = 3.6431 + [COE *.5714]

15-3.6431 = .5714COE

COE = 11.3569/.5714

      = 19.88%

Correct option is "B"

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