Question

You are opening a landscaping business, and wish to estimate your levered cost of equity. Beatrice's Yard Maintenance has an equity beta of 1.6, and a D/E ration of 1.0. If the riskless rate is 0.03, the expected return on the S&P500 is 0.14, and your firm will have a D/E ratio of 1, what would your firm's levered cost of equity be if the tax rate is 0.29? Please give your answer in the form of a decimal to 2 places - if your answer is 10.5%, please enter 0.105.

Answer 1

Equity Beta of Beatrice's = 1.6

Unlevered Beta = Equity Beta*[1/[1+(1-tax rate)*(D/E)]]

Unlevered Beta of Beatrice's = 1.6*[1/[1+(1-0.29)*(1)]]

= 1.6*(1/1.71)

= 0.9357

Equity Beta = Unlevered Beta*[1+(1-tax rate)*(D/E)]

Equity Beta of landscaping business = 0.9357*[1+(1-0.29)*(1)]

= 1.6

Levered cost of equity = Riskless rate + Levered Beta*(Market rate-Riskless rate)

= 0.03 + 1.6(0.14-0.03)

= 0.03 + 1.6*(0.11)

= 0.206

Therefore, levered cost of equity is 0.206