Answer:
change in equity cost is 1.70%
Step-by-step explanation:
given data
tax rate T = 40%
beta b = 1.10
debt D = 30%
equity E = 70%
risk-free rate RR = 5.0%
risk premium RP = 6.0%
to find out
the capital structure shift change the firm cost of equity
solution
we know here debt and equity so
Target D/E will be = [tex]\frac{30}{70}[/tex]
Target D/E = 0.43
levered beta = beat ( 1 + D/E × (1 - tax rate) )
levered beta = 1.10 ( 1 + 0.43 × (1 - 40%) )
levered beta = 1.3828571
and
cost of equity unlevered = risk-free rate + beta (risk premium)
cost of equity unlevered = 5% + 1.1 (6%) = 11.60%
and
cost of equity levered = risk-free rate + levered beta (risk premium)
cost of equity levered = 5% + 1.38 (6%) = 13.30%
so change in equity cost will be = 13.30% - 11.60%
change in equity cost is 1.70%
