Question

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MOOOHOOO Corp (MH) has debt to equity ratio of 1 and an equity beta of 1.90....

MOOOHOOO Corp (MH) has debt to equity ratio of 1 and an equity beta of 1.90. Currently MH’s debt cost of capital is 5.5%. If MH is considering a change: by issuing debt to buyback stock to have a debt-equity ratio of 2 that it will maintain this ratio forever. With this change assume MH’s cost of debt capital will be 6% and their tax rate is 35%. If the expected market return is 9% and the risk free rate is 5% answer the following questions:

7) What is the current equity cost of capital of the firm?

  1. re=.151     
  2. re= .144    
  3. re=   .126  
  4. re=   .101  
  5. re= .091  

Solutions

Expert Solution

Equity Beta = 1.90

Expected market return (Rm) = 9%

Risk free rate of return (Rf)= 5%

Current equity cost of capital by CAPM formula can be calculated by:

Re = Rf + (Rm - Rf) * Beta

Re = 0.05 + (0.09 - 0.05) * 1.90

Re = 0.05 + 0.04*1.90

Re = 0.05 + 0.076

Re = 0.126

The correct answer is C i.e. re= 0.126

jeff jeffy answered 2 years ago
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