Cartwright Communications is considering making a change to its capital structur

Question

Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value. Right now, Cartwright has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6% and the market risk premium, rM-rRF is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Cartwright's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?

Hint: Do the following 4 steps.

Step 1: Find the firm's current levered beta using the CAPM.

Step 2: Find the firm's unlevered beta using the Hamada equation.

Step 3: Find the new levered beta given the new capital structure using the Hamada equation.

Step 4: Find the firms new cost of equity given its new beta and the CAPM:.

13.00%

13.64%

14.35%

14.72%

15.60%

13.00%

13.64%

14.35%

14.72%

15.60%

Explanation / Answer

14.35%

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