# What will be the cost of equity if capital structure changed?

Cost of Equity if Capital Structure changed to 50/50?

Current capital structure: 20 percent debt and 80 percent equity, based on market values. (Its D/S ratio is 0.25.)

The risk-free rate is 6 percent and the market risk premium, rM - rRF, is 5 percent. Currently the company's cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent.

What would be the Company's estimated cost of equity if it were to change its capital structure to 50 percent debt and 50 percent equity?

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#### Solution Preview

CAPM says

rS=rRF+Equity Beta*rM-rRF)

We have rS=12%

rM-rRF=5%

rRF=6%

hence, 12%=6%+Equity ...

#### Solution Summary

The solution determines a company`s estimated cost of equity if it were to change its capital structure to 50 percent debt and 50 percent equity.

$2.19