Suppose you borrow $120000 when financing a coffee shop which is valued at $175000. Assume that the unlevered cost of capital for the coffee shop is 7.5% and that the cost of debt is valued at 9%. What should be the cost of equity of your firm? Note: Express your answers in strictly numerical terms. For example, if the answer is 5%, write 0.05"
Question
Suppose you borrow 175000. Assume that the unlevered cost of capital for the coffee shop is 7.5% and that the cost of debt is valued at 9%. What should be the cost of equity of your firm? Note: Express your answers in strictly numerical terms. For example, if the answer is 5%, write 0.05"
Solution
To find the cost of equity, we can use the Modigliani-Miller theorem, which states that the cost of equity is equal to the unlevered cost of capital plus the cost of debt times the debt-to-equity ratio.
First, we need to find the debt-to-equity ratio. The debt is 175,000 - 55,000. So, the debt-to-equity ratio is 55,000 = 2.18.
Next, we can calculate the cost of equity. The unlevered cost of capital is 7.5% or 0.075, the cost of debt is 9% or 0.09, and the debt-to-equity ratio is 2.18. So, the cost of equity is 0.075 + 0.09 * 2.18 = 0.2712 or 27.12%.
Similar Questions
What is the company cost of capital for a firm financed with 30% debt if the debt requires a 10% return and equity requires a 16% return?
The cost of capital is the same as the cost of equity for firms that are financed:Group of answer choicesentirely by debt.entirely by equity.by 50 percent equity and 50 percent debt.by both debt and equity.
Q1 A firm has total assets worth $49, 000. lt has borrowed $10, 000 at 8.0%. If its WACC (without tax) is 16.0%, what is the firm's cost of (levered) equity capital? The firm's cost of equity capital is places. ???%. (Round to 2 decimal)
Axon Industries needs to raise $1000000 USDs for a new investment project. If the firm issues 1-year debt, it may have to pay an interest rate of 10%, although Axon's managers believe that 8% would be a fair rate given the level of risk. If the firm issues equity, they believe the equity may be underpriced by 9%.What is the cost (in USDs) to current shareholders of financing the project out of debt? Note: Express your answers in strictly numerical terms. For example, if the answer is $500, enter 500 as an answer."
Question 8If a company has $30,000 debt and $60,000 equity, what is its debt to equity ratio?
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.