The Pizza Shoppe has debt with both a face and a market value of $3,000.This debt has a coupon rate of 7 percent and pays interest annually.The expected earnings before interest and taxes are $1,200,the tax rate is 34 percent,and the unlevered cost of capital is 12 percent.What is the firm's cost of equity?
A)13.25%
B)13.89%
C)13.92%
D)14.14%
E)14.25%

Question

Quizplus · Accepted Answer

V_U = [$1,200 × (1 - .34)]/.12 = $6,600V_L = $6,600 + (.34 × $3,000)= $7,620V_S = $7,620 - 3,000 = $4,620R_S = .12 + ($3,000/$4,620)(1 - .34)(.12 - .07)= .1414,or 14.14%

The Pizza Shoppe Has Debt with Both a Face and a Market