Cost of Equity, AB Corporation has 16% cost of equity, 35% tax rate, and debt-to-equity

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.

View Complete Question

Comments & Conversion

Expert

Verified

Emerson’s Cost of equity = 16% = 4% + B_L (12% - 4%)
8% B_L = 12%
B_L = 1.5
B_u = B_L/(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%,

B_L = B_U (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 : Compute betas against local indexes

Does it make any sense to compute betas against local indexes while a company has a great part of its operations outside such local market? I have two illustrations: BBVA and Santander.

Q : What is the market risk premium What is

What is the market risk premium within Spain at the present time – the number that I have to use in the valuations?

Q : Real estate problem Eric Rowan is

Eric Rowan is planning to buy a house for $155,000 by borrowing money at the rate of 9%. He expects to rent the house for 5 years, collecting $20,000 annual rent in advance each year. He thinks that he can sell the house for $175,000 after five years. Fulton has incom

Q : Bond price problem ABC Corp is issuing

ABC Corp is issuing a 10-year bond with a coupon rate of 7 %. The interest rate for similar bonds is at present 9 %. Supposing annual payments, what is the current value of the bond? (Round to the closest dollar.) (a) $872 (b) $1,066 (c) $990 (d) $945.

Q : Calculating Super normal profit The

The case study of an economic analysis is done for Schlumberger, oilfield Service Company. They are No. 1 in terms of market caps, revenue and employees globally. When any references are used/outside sources (except for Schlumberger's annual reports and financia

Q : Problem on maintaining dividend Jackson

Jackson Company has 6 million shares of common stock selling at $55 each. It also has $120 million in long-term bonds with coupon 7%, selling at 90. The tax rate of Jackson is 33%. Next year its EBIT is expected to be $25 million with a standard deviation of $7 millio

Q : Selling or purchasing problem Atlas

Atlas Realty Company is interested in buying a house and renting it out for $12,000 a year, collecting the rent in advance each year. This will depreciate the house over 25 years; however sell it after 15 years at twice its purchase price. The maintenance expenditures

Discover Q & A

Leading Solution Library

Avail More Than 1448129 Solved problems, classrooms assignments, textbook's solutions, for quick Downloads

No hassle, Instant Access

Start Discovering

18,76,764

1946648
Asked

3,689

Active Tutors

1448129

Questions
Answered

Start Excelling in your courses, Ask an Expert and get answers for your homework and assignments!!

Submit Assignment