Al's Pub has debt with both a book and a market value of $120,000. This debt has a coupon rate of 9% and pays interest annually. The expected earnings before interest and taxes are $42,600, the tax rate is 34%, and the unlevered cost of capital is 11%. What is the firm's cost of equity?
A) 11.90%
B) 12.07%
C) 12.11%
D) 12.15%
E) 12.18%

Question

Quizplus · Accepted Answer

The correct answer is A because the cost of equity is 11.90%. The formula for the cost of equity is: Cost of equity = Unlevered cost of capital + (Unlevered cost of capital - Debt cost) * (Debt / Equity). Plugging in the numbers, we get: Cost of equity = 11% + (11% - 9%) * (120,000 / 42,600) = 11.90%.

Al's Pub Has Debt with Both a Book and a Market