QUESTION 5 A firm has $20 in debt at YTM= 10%. The firm has $25 in equity, and s

Question

QUESTION 5 A firm has $20 in debt at YTM= 10%. The firm has $25 in equity, and stockholders expect a 15% return. If the firm changes its capital structure to DE-2, what will be the new cost of equity? Tax rate is 0%-(Hint: use M&M; proposition 2) OA. 12.7% B. 18.3% QUESTION 6 You have an idea that requires an investment of $60 today, and is expected to produce $104.5 in one period. Given the riskiness of your idea, the appropriate discount rate is 10%. You raise $30 by issuing debt at YTM=0%, and you will sell equity in order to raise the remainder. what fraction of ownership in your idea (what percentage of E) do you need to sell? Tax rate is 0%. OA. 50.0% B. 45.5% O. C. 46.2% D. 28.7%

Explanation / Answer

Cost of Equity = Opportunity Cost of Capital + ( Opportunity Cost of Capital - Cost of Debt) X Debt / Equity

Here opporunity Cost of Capital = Weighted Average Cost of Equity and the Cost of Debt.

Now , Weighted Average cost of Equity = 15% X 25/ 45 = 0.083

Cost of Debt = 0.10 X 20/45 = 0.04,

So Opportunity cost of capital = 0.127

Now cost of equity = 0.127 + ( 0.127-0.44) X 2

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