Calculate the company's cost of equity given the following information: return on assets 10.5%; return on debt 8.75%; total debt $995,000; total equity $1,520,000. Tax rate 40%.
A) 11.19%
B) 12.29%
C) 13.39%
D) 14.49%
E) 15.59%

Question

Quizplus · Accepted Answer

The correct answer is A because the cost of equity is calculated as the return on assets plus the risk premium, which is the difference between the return on equity and the return on debt. The return on equity is calculated as the return on assets times the equity multiplier, which is the ratio of total assets to total equity. The risk premium is calculated as the return on debt times the debt-to-equity ratio, which is the ratio of total debt to total equity. The cost of equity is then calculated as the return on assets plus the risk premium, which is 10.5% + (8.75% x (995,000 / 1,520,000)) = 11.19%.

Calculate the Company's Cost of Equity Given the Following Information