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Cost of Capital and Debt

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A. Generally, which of the following is true? (where rE is the cost of equity, rD is the cost of debt and rA s the cost of capital for the firm.

A. rD> rA> rE
B. rE> rD> rA
C. rE> rA> rD
D. None of the above is true

B. If a firm is unlevered and has a cost of equity capital 9%, what would the cost of equity be if the firms became levered at a debt-equity ratio of 2? The expected cost of debt is 7%. (Assume no taxes.)

A. 15.0%
B. 16.0%
C. 14.5%
D. 13%

C. A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes its cost of equity capital with the new capital structure would be:

A. 8%
B. 16%
C. 13%
D. 10%
E. None of the above

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Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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