HAMADA EQUATION Situational Software Co. (SSC) is trying to establish its optima

Question

HAMADA EQUATION Situational Software Co. (SSC) is trying to establish its optimal capital structure. Its current capital structure consists of 30% debt and 70% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, rRF, is 6%; the market risk premium, RPM, is 7%; and the firm's tax rate is 40%. Currently, SSC's cost of equity is 15%, which is determined by the CAPM. What would be SSC's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? Round your answer to two decimal places. Do not round intermediate steps. %

Explanation / Answer

beta=(15%-6%)/7%

=1.29

unlevered beta=1.29/(1+(1-40%)*(30%/70%))=1.03

now Beta at 50% debt

1.03=x/(1+(1-40%)*(50%/50%))

x=1.03*(1+(1-40%)*(50%/50%))=1.65

cost of equity=6%+1.65*7%=17.55%

the above is the answer

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