--%>
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 : Active versus Passive fund managers

    Active vs. Passive fund managers: Passive fund managers adopt a long term buy and hold strategy. Usually, stocks are purchased so that the portfolio’s returns will track those of an

    		•
  • Q : What is Financial Analysis Financial

    Financial Analysis: It is the investigation and interpretation of financial statements and associated financial reports. Trained and certified accountants generally complete this kind of analysis. The role of a financial analyst is to

    		•
  • Q : What is Net Operating Profit after Tax

    What is Net Operating Profit after Tax (NOPAT)?

    		•
  • Q : Bond Price Information What is Bond

    What is Bond Price Information: Answer: Corporate bond market is not considered to be much transparent as it trades predominantly over the counter and investors do n

    		•
  • Q : Explain Butterfly Spread Strategies

    Butterfly Spread Strategies: In this strategy, there is no limit on the number of options that can be combined to form the butterfly spread. This strategy essentially combines both the bear spread and the bull spread. In this case, options with three

    		•
  • Q : Explain company creates value for its

    Is this true that a company creates value for its shareholders in a year when this distributes dividends or when the quotation of the shares increases?

    		•
  • Q : Convertible Bonds-Corporate Bonds State

    State the term Convertible Bonds in Corporate Bonds?

    		•
  • Q : Define the term Stock Market crash

    Stock Market Crash was responsible for the Great Depression. Middle class families lost all their savings as they had gambled the market on margin.Those banks which were under the loan ofbrokers’ started removing money out of the savings account

    		•
  • Q : Problem on optimal capital structure

    XYZ Company has debt/assets ratio 50%, that is too high and it must be at 45% to be optimal. This debt reduction must also reduce the bankruptcy costs by $30 million. At present, XYZ has 5 million shares of common stock selling at $50 each. The tax rate of XYZ is 30%.

    		•
  • 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?

    		•