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MM Extension with growth: What is Firm L's cost of equity?

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Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity?
a. 11.4%

b. 12.0%

c. 12.6%

d. 13.3%

e. 14.0%

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Solution Summary

This solution is comprised of detailed calculation for the following:

Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity?

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Here is the formula for finding the cost of equity with regards to M&M Proposition II with corporate taxes:
RE = RU + ...

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