A ﬁrm has zero debt in its capital structure.Its overall cost of capital is 9%.The ﬁrm is considering a new capital structure with 40% debt.The interest rate on the debt would be 4%.Assuming that the corporate tax rate is 34%, what
Would its cost of equity capital with the new capital structure be?
A)10.3%
B)11.0%
C)11.2%
D)13.9%
E)None of the above.

Question

Quizplus · Accepted Answer

The correct answer is C.The cost of equity capital with the new capital structure can be calculated using the weighted average cost of capital (WACC) formula:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)where:E/V = proportion of equity in the capital structureD/V = proportion of debt in the capital structureRe = cost of equity capitalRd = cost of debt capitalTc = corporate tax rateIn this case, E/V = 0.6, D/V = 0.4, Rd = 4%, and Tc = 34%. Substituting these values into the WACC formula, we get:WACC = (0.6) * Re + (0.4) * 4% * (1 - 0.34)WACC = 0.6Re + 0.264Since the overall cost of capital is 9%, we have:0.6Re + 0.264 = 9%0.6Re = 8.736%Re = 11.2%

A ﬁRm Has Zero Debt in Its Capital Structure