Are the answers correct and if not can you show the formula to solve fror them..

Question

Are the answers correct and if not can you show the formula to solve fror them...

Maitland Inc. currently has a capital structure consisting of 25% debt and 75% equity. However, Maitland's CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 6% and the market risk premium is 5%, while Maitland's beta is 1.15. If the firm's tax rate is 40%, what would the beta of an all-equity firm be if its operations were exactly the same? 0.9130 0.8750 1.1250 0.9583 1.1534 If Maitland raised its debt ratio to 50%, how much would its cost of equity change? 2.50% 2.00% 1-92% 1-77% 2.25%

Explanation / Answer

Hi,

Please find the answer as follows:

Part A

Beta =1.15/[1+(1-.40)*.25/.75] = .9583

Part B

Beta =1.15/[1+(1-.40)*.50/.50] = .71875

Cost of equity (original) = 6% + 1.15*(5%) = 11.75%

Cost of equity (revised) = 6% + .71875*(5%) = 9.59%

Change in equity = 11.75% - 9.59%% = 2.15% (You can take it as 2.25%). It is because of approximations.

Thanks, Aman

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