Alpha Co. has a debt-equity ratio of 0.6, a pretax cost of debt of 7.5 percent, and an unlevered cost of equity of 12 percent. What is Alpha's cost of equity if you ignore taxes?Multiple choice question.16.5%12%14.7%9.3%
Question
Alpha Co. has a debt-equity ratio of 0.6, a pretax cost of debt of 7.5 percent, and an unlevered cost of equity of 12 percent. What is Alpha's cost of equity if you ignore taxes?Multiple choice question.16.5%12%14.7%9.3%
Solution
The cost of equity can be calculated using the formula:
Cost of Equity = Unlevered cost of equity + (Unlevered cost of equity - Pretax cost of debt) * (Debt/Equity ratio)
Given that the unlevered cost of equity is 12%, the pretax cost of debt is 7.5%, and the debt-equity ratio is 0.6, we can substitute these values into the formula:
Cost of Equity = 12% + (12% - 7.5%) * 0.6 = 12% + 4.5% * 0.6 = 12% + 2.7% = 14.7%
So, the cost of equity for Alpha Co., ignoring taxes, is 14.7%.
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