Question

The required return on equity for an all-equity firm is 10.0 percent. They are considering a change in capital structure to a debt-to-equity ratio of 1/2, the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the new cost of capital if this firm changes capital structure.

Answer 1

The new cost of capital if this firm changes capital structure is 1.3

Step-by-step explanation:

From the provided information:

All equity beta = 1

New D/E ratio = 0.5

Then, the new capital structure with levered beta is given by:

new capital structure = All equity beta *(1 + D/E*(1 - tax rate))

= 1*(1 + 0.5*(1 - 40%))

= 1.3

Therefore, The new cost of capital if this firm changes capital structure is 1.3