--%>
Assignment Help - homework help

Cost of Equity

AB Corporation has 16% cost of equity, 35% tax rate, and debt-to-equity ratio of 30%. XY Corporation has 30% tax rate and debt-to-equity ratio of 40%. Both AB and XY are in the same business of selling automotive parts. If the riskless rate is 4% and the expected return on the market is 12%, find the cost of equity for XY.

E

Expert

Verified

Emerson’s Cost of equity = 16% = 4% + BL (12% - 4%)
8% BL = 12%
BL = 1.5
Bu = BL/(1 + (1 – T)(D/E)) = 1.5/(1 + (1 – 0.35)(0.3) = 1.5/1.195 = 1.255

Hence with a D/E ratio of 40%,

BL = BU (1 + (1 – T)(D/E)) = 1.255 (1 + (1 – 0.3)(0.4)) = 1.61

Cost of equity = 4% + 1.61*(12% - 4%) = 16.85%

   Related Questions in Corporate Finance

  • Q : Financial statements The concept of

    The concept of conservatism has been influential in the development of accounting theory and practice.  A major effect of conservatism is that accountants tend to recognize losses but not gains.  For example, when the value of an asset is impaired, it is wri

    		•
  • Q : Efficient Market Hypotheses Write

    Write Efficient Market Hypotheses in brief?

    		•
  • Q : Low-discrepancy sequence or quasi

    Who proposed definition and development of low-discrepancy sequence theory or quasi random number theory?

    		•
  • Q : Does the equity of shareholders have

    Does the equity of shareholders represents the savings a company has accumulated by the years?

    		•
  • Q : Problem on car rental plans Ape Car

    Ape Car Rental plans to begin its business by buying 10 cars at the average price of $18,000 each, depreciating them entirely over 5 years utilizing the straight-line method. It will rent space in a parking lot for $300 a month, paying the rent in advance every month.

    		•
  • Q : Types of agency Types of agency :

    Types of agency: Specific types of Agency include:A) Auctioneers: Are an agent of vendor until the fall of the hammer when they become an agent for the purchaser.B)

    Q : Financing EBIT problem Rusk Inc needs

    Rusk Inc needs $50 million in new capital that it might obtain by selling bonds at par with coupon of 12% or by selling stock at $40 (net) per share. The current capital structure of Rusk consists of $300 million (face value) of 10% coupon bonds selling at 90 and 10 m

    		•
  • Q : Liquidity Ratios Liquidity Ratios :

    Liquidity Ratios: Such ratios comprise the Current Ratio and the Quick Ratio or the acid test ratio. Liquidity ratios demonstrate the Liquid position of a company in the short term that is the capability of a firm to pay its obligations in short term.

    		•
  • Q : Explain influences of financial

    Does financial leverage (i.e. debt) have any influence on the Free Cash Flow, upon the Cash Flow to Shareholders, upon the growth of the company and upon the value of the shares?

    		•
  • Q : Which data is the most suitable for

    Which data is the most suitable for finding betas?

    		•