A firm has a debt-to-equity ratio of 1.20. If it had no debt,its cost of equity would be 15%. Its cost of debt is 10%. What is its cost of equity if there are no taxes or other imperfections?
A) 10%
B) 15%
C) 18%
D) 21%
E) None of these.

Question

Quizplus · Accepted Answer

The cost of equity can be calculated using the Modigliani-Miller Proposition II without taxes: Cost of Equity = Cost of Equity without debt + (Debt/Equity) * (Cost of Equity without debt - Cost of Debt). Here, it is 15% + 1.20 * (15% - 10%) = 21%.

A Firm Has a Debt-To-Equity Ratio of 1