Suppose the cost of capital of the Gadget Company is 11 percent. If Gadget has a...
Suppose the cost of capital of the Gadget Company is 11 percent. If Gadget has a capital structure that is 57 percent debt and 43 percent equity, its before-tax cost of debt is 6 percent, and its marginal tax rate is 20 percent, then its cost of equity capital is closest to: Entry field with incorrect answer now contains modified data
14.2 percent.
16.2 percent.
12.2 percent.
18.2 percent.
Homework Answers
Answer: Option D
Explanation: Given that, Cost of capital = WACC = 11% = 0.11
Tax rate = T = 20% = 0.20
Debt weight = D = 57% = 0.57
Equity weight = E = 43% = 0.43
Before tax cost of Debt = Kd = 6% = 0.06
Let Cost of equity = Ke
We know that, Cost of Capital,
WACC = (Kd x D x (1-T)) + (Ke x E)
0.11 = (0.06 x 0.57 x (1-0.20)) + (Ke x 0.43)
0.11 = 0.02736 + 0.43Ke
Ke = 0.1921
Ke = 19.21% = Cost of Equity
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