Question

Jacque Ewing Drilling, Inc. has a beta of 1.3.. If the risk-free rate of return is 8 percent and the expected return on the market is 12 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 40 percent?

A) 7.92%
B) 13.20%
C) 15.57%
D) 23.60%

Answer 1

The firm's after-tax cost of equity capital is calculated using the CAPM formula; the after-tax cost remains the same as the before-tax cost since dividends are not tax-deductible. Hence, Jacque Ewing Drilling, Inc.'s after-tax cost of equity is 13.20%.

Step-by-step explanation:

To calculate the after-tax cost of equity, we can use the Capital Asset Pricing Model (CAPM), which is given by the formula:

Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

First, we calculate the before-tax cost of equity for Jacque Ewing Drilling, Inc. using the provided figures:

Risk-Free Rate = 8%
Beta = 1.3
Expected Market Return = 12%

Before-tax Cost of Equity = 8% + 1.3 * (12% - 8%) = 8% + 1.3 * 4% = 8% + 5.2% = 13.20%

The firm's marginal tax rate does not affect its cost of equity capital because dividends are not tax-deductible expenses. Therefore, the after-tax cost of equity is the same as the before-tax cost of equity.

So, the correct answer is B) 13.20%.