Question

sheila pays corporate taxes. the girm has a debt equity ratio of 1. the pre tax cost of debt if 1.5% while the unlevered cost of capital is 10%. what is the approximate cost of equity if the tax rate is 35%?

A. 10%

B. 8.2%

C. 11.8%

D. 19.9%

E. 15.5%

Answer 1

As per Modigliani Miller (proposition 2)

The Cost of equity = cost of capital + D/E* (cost of capital - cost of Debt) * (1-tax rate)

=10%+ 1* (10%-1.5%)* (1-35%)

=15.525% or approximately 15.5%

Option E is the correct answer