Question

King's unlevered cost of equity is 11 percent and its pretax cost of debt is 8 percent. The firm has a debt-equity ratio of .4. If the tax rate is 40 percent, what is King's cost of equity?

Answer 1

Answer:

11.72%

Explanation:

Find levered cost of equity using the formula below;

kL $=kU +(1-tax)\frac{D}{E} (kU-kD)$

whereby;

kU = unlevered cost of equity = 11% or 0.11 as a decimal

kL = levered cost of equity

D/E = debt-equity ratio = 0.4

tax = 40% or 0.40 as a decimal

Next, plug in the numbers to the formula above;

$kL = 0.11 + [(1-0.40)*0.4*(0.11-0.08)]\\ \\ =0.11 + 0.0072\\ \\ =0.1172$

As a percentage, the King's levered cost of equity is 11.72%