Question

Assume the corporate tax view of capital structure. Your unleveraged cost of capital is 13%. Your corporate tax rate is 30%. Your firm proposes to borrow $800 and its leveraged firm value is $1,600. What is your cost of capital under the proposed leveraging

Answer 1

11.05%

Step-by-step explanation:

Use the following formula to calculate the cost of capital under the proposed leveraging

Cost of capital = ( Debt /Firm value ) x ( ( Unlevered cost of capital x ( 2 - tax rate ) )

Where

Debt = $800

Firm Value = $1,600

Unlevered cost of capital = 13%

Tax Rate = 30%

Placing values in the fromula

Cost of capital = ( $800 / $1,600 ) x ( ( 13% x ( 2 - 30% ) )

Cost of capital = 0.50 x ( 0.13 x 1.70 )

Cost of capital = 0.50 x 0.221

Cost of capital = 0.1105

Cost of capital = 11.05%