Cost of Equity for ABC Inc.
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ABC Inc. has debt with both a face and a market value of $3,000. This debt has a coupon rate of 7% and pays interest annually. The expected earnings before interest and taxes is $1,200, the tax rate is 34%, and the unlevered cost of capital is 12%. What is the firm's cost of equity?
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The solution explains step-by-step how to calculate the cost of equity.
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According to Modigliani-Miller Proposition II with corporate taxes:
rS = r0 + (B/S)(r0 - rB)(1 - TC)
where r0 = the required return on the equity of an unlevered firm
rS = the required return on the equity of a levered firm
rB = ...
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