Question

Alabaster Incorporated wants to be levered at a debt-to-value ratio of .6. The cost of debt is 9 percent, the tax rate is 35 percent, and the cost of equity for an all-equity firm is 12 percent. What will be Alabaster's cost of equity?

Answer 1

Answer:

Return on Equity = 13.17%

Explanation:

We solve for cost of equity using the MM model with taxes.

$r_e = r_a + \frac{D}{E} (r_a-r_d)(1-t)$

r_a = retrun on asset or unlevered return =0.12

D/E = 0.60

r_d = cost of debt = 0.09

taxes = 35% = 0.35

re = return on equity = 0.1317 = 13.17%