--%>
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 : Why required return cannot computed by

    Why can we not compute the required return (Ke) by the Gordon-Shapiro model [P0 = Div0 (1+g) / (Ke – g)] in place of using the CAPM? As we identify the current dividend (Div0) and the current share price (P0), we can acquire the growth rate of the dividend by th

    		•
  • Q : Explain the definition of WACC An

    An investment bank computed my WACC. The report is as: “the definition of the WACC is defined as WACC = RF + βu (RM – RF); here RF being the risk-free rate and βu the unleveraged beta and RM the market risk rate.” It is differ from what we

    		•
  • Q : Explain exotic option-value of option

    Explain exotic option’s value of option pricing method.

    		•
  • Q : Could we explain that goodwill is equal

    Could we explain that goodwill is equal to brand value?

    		•
  • Q : Is this better to repurchase shares or

    Assuming a company needs to distribute money to shareholders of it, is this better to repurchase shares or to distribute dividends?

    		•
  • Q : Option Trading Strategies Explain the

    Explain the term Option Trading Strategies?

    		•
  • Q : Minimum pretax earnings XYZ Company is

    XYZ Company is planning to acquire a machine which will cost $200,000, that will last for 4 years. The company employs straight-line depreciation. The tax rate of XYZ is 35% and the proper discount rate in this situation is 12%. (A

    		•
  • Q : Explain essential hypotheses for

    Which are the essential hypotheses so that valuations of the Economic Value Added (EVA) give similar results to discounting cash flows?

    		•
  • Q : Market for Corporate Bonds Write some

    Write some point regarding Market for Corporate Bonds.

    		•
  • Q : Broad research methodologies Various

    Various broad research methodologies are available with which to study the development of accounting theory. a. Discuss the deductive, inductive, normative, and empirical research methods.