What would be FFC’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? Should the company opt new capital structure, decide based on the cost of equity computations?

What would be FFC’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? Should the company opt new capital structure, decide based on the cost of equity computations?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 25P

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Question

FFC is trying to establish its optimal capital structure. Its current capital structure consists of 25% debt and 75% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, rRF, is 4%; the market risk premium, RPM, is 5%; and the firm’s tax rate is 40%. Currently, FFC has beta of 1.5. What would be FFC’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? Should the company opt new capital structure, decide based on the cost of equity computations?

Definition Definition Amount of return a company generally pays to its equity investors. The cost of equity represents the compensation required by the market in lieu of owning the asset firm and simultaneously bearing the risk of ownership.

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