Question

Ballard Systems is currently an all equity firm. The firm has a cost of capital of 10.48 percent. Ballard Systems is considering switching to a debt-equity ratio of 1.80 with a pretax cost of debt of 8.2 percent. What 4-will the firm's cost of equity be if it makes the switch? Ignore taxes. 14.27% C 14.58% C 14.73% C 14.98% C 15.21%

Answer 1

According to MM proposition-II (without tax), Levered Cost of Equity can be computed with following equation

$K_{eL} = K_{eU} + \frac{Debt}{Equity}*(K_{eU}-K_d)$

where,

Ke = Cost of equity

Kd = cost of debt

U = unlevered

L = levered

Putting the values:

$K_{eL} = 0.1048 + 1.80*(0.1048-0.082)$

$K_{eL} = 0.1048 + 1.80*0.0228$

$K_{eL} = 0.1048 + 0.04104$

$K_{eL} = 0.14584$

$\bg_green \large K_{eL} =14.58\%$

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.