Answered

A firm has a debt-equity ratio of .64, a pretax cost of debt of 8.5 percent, and a required return on assets of 12.6 percent. What is the cost of equity if you ignore taxes

Answer :

Answer:

15.22%

Explanation:

The computation of the cost of equity is shown below:

Required return on assets = Weightage of debt × pre tax cost of debt + weightage of  equity × cost of equity

where,

Weightage of debt is

= (Debt) ÷ (Debt + Equity)

= (0.64) ÷ (0.64 + 1)

= 0.39

And, the weightage of equity is

= (Equity) ÷ (Debt + Equity)

= (1) ÷ (0.64 + 1)

= 0.61

Now the cost of equity is

12.6% = 0.39 × 8.5% + 0.61 × cost of equity

12.6% = 3.315% + 0.61 × cost of equity

So, the cost of equity is 15.22%

Other Questions