FIN515 quiz 3

Question 3.
Question :
(TCO E) A company has a capital structure of 40% debt and 60% equity. The YTM on the company’s bonds is 9%, and the company’s effective tax rate is 40%. The CFO has estimated the company’s WACC to be 9.96%. What is the company’s cost of equity? Show your work.
 
Student Answer:
 
9.96% = (.4)(9%)(1 - 0.4) + (0.6)(Cost of Equity) 9.96% = 2.16% + (0.6)(Cost of Equity) 7.80% = 0.6 * Cost of Equity Cost of Equity = 7.8 / 0.6 = 13%
 
Instructor Explanation:
9.96=.60*RE + .40*.09*(1-.40)
RE=13%
Chapter 12
 
 
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