Question

Clifton Chemical Industries (CCI) has a D/E = 1.5. The firm's WACC is 12%, and its cost of debt is 12%. The corporate tax rate is 35%. This would imply a CoE = 18.3%. CCI's unlevered cost of equity capital is thus closer to:

a. 15.19%
b. 16.23%
c. 18.99%
d. 17.31%
e. 19.98%

Answer 1

The unlevered cost of equity capital for CCI is closest to 15.19%.

Step-by-step explanation:

The unlevered cost of equity capital can be calculated using the formula:

CoE = WACC - (D/E) * (Cost of Debt) * (1 - Tax Rate)

Given that CCI has a D/E ratio of 1.5, WACC of 12%, cost of debt of 12%, and a corporate tax rate of 35%, we can substitute these values into the formula:

CoE = 12% - (1.5) * (12%) * (1 - 0.35) = 12% - 18% = -6%

Since a negative cost of equity doesn't make sense, we can conclude that the closest option is a. 15.19%.