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# The required return on equity for a levered firm is 10. The debt to equity ratio is the tax rate is 40%, the pretax cost of debt is 8%. Find the cost...

ch18#18. pls see attached

The required return on equity for a levered firm is 10.60%. The debt to equity ratio is ½ the tax rate is 40%, the pre-tax cost  of debt is 8%. Find the cost of capital if this firm were financed entirely with equity. Feedback:          From Modigliani and Miller proposition 2 the required return on equity for a levered firm is  K l  =  K u  + (1-  )( τ K i )(Debt/Equity) (Instructors note: some students will select b) the WACC. Students who have had corporate finance should know M&M  proposition 2. Good questions for graduate courses.) My Question:    Do you substitute ½ in for D/E?  I still don’t get to 10%?  Where does the  1.30 come from?  Can you pls show all the work to get to the answer of 10%?  I don’t  know where the numbers come from.

Solution: ½ is substituted for D/E ratio, and for 1.3 pls find below:
10.6% = r + D/E × (r – 8%)(1-.40)
10.6 = r + 1/2 x (r – 8) x 0.60
10 .6= r + 0.5r – 4 * 0.60
10 .6= r + 0.30r – 2.4...

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