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cost of equity of Anderson's Furniture Outlet

1. Anderson's Furniture Outlet is levered firm with a tax rate of 34% and expected earnings before interest and taxes (EBIT) of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are currently selling at par value. For simplicity, you may assume perpetual EBIT and perpetual loans.

The company's financial analyst suggests two comparable firms for benchmarking purpose.

The Boyles Design Studio is private firm but it has a debt-to-equity ratio of 0.2 and its outstanding bonds are publicly traded with a yield to maturity of 5%. There is no information about Boyles' stock beta since it has no publicly traded shares.
The Ethan Stores is an all-equity firm with publicly traded shares and the company's cost of equity capital is 10%.

According to the MM theory, what should be the cost of equity of Anderson's Furniture Outlet?

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MM Theory
1. Anderson's Furniture Outlet is levered firm with a tax rate of 34% and expected earnings before interest and taxes (EBIT) of $1,600. The company has $3,000 in bonds outstanding that have an 8% coupon and pay interest annually. The bonds are currently selling at par value. For simplicity, you may assume perpetual EBIT and perpetual loans.

The company's financial analyst suggests two comparable firms for benchmarking purpose.

The Boyles Design Studio is private firm but it has a debt-to-equity ratio of 0.2 and its ...

Solution Summary

The cost of equity of Anderson's Furniture Outlet is determined.

$2.19