Question

Anderson's Furniture Outlet has an unlevered cost of capital of 10.3 percent, a tax rate of 34 percent, and expected earnings before interest and taxes of $1,900. The company has $4,000 in bonds outstanding that have an annual coupon of 7 percent. If the bonds are selling at par, what is the cost of equity

Answer 1

The cost of equity= 11.21%

Step-by-step explanation:

VL=Value UnLevered + Debt*Tax Rate =EBIT*(1-Tax Rate)/Unlevered Cost of Capital +Tax *Debt

=1900*(1-34%)/10.3%+34%*4000

=13534.76

Value of equity = $13,534.76 – 4,000 =9434.757

Cost of Equity = Cost of Unlevered Equity +(Debt/Equity)*(1-Tax Rate)*(Cost of Unlevered Equity-Cost of Debt)

=10.30%+(4000/9434.757)*(1-34%)*(10.3%-7%)

=11.21%