Longmont Inc is in the property management business and has a required return on

Question

Longmont Inc is in the property management business and has a required return on its assets of 10%. It can borrow in the debt market at 5%. If there are no taxes and M&Ms proposition II hold, what is the cost of equity if there is 10% equity financing and 90% debt financing?

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Explanation / Answer

Ke = Ko + D/E(Ko-Kd) = 0.10 + (90/10)(0.10-0.05) = 0.10 + 0.045 = 0.145 0r 14.50%.

Where Ko is Overall cost i.e. ROA

D/E is Debt/Equity

Kd is cost of debt

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