Simon Software Co

question 3

Multiple Choice

Simon Software Co. is trying to estimate its optimal capital structure. Right now, Simon has a capital structure that consists of 20% debt and 80% equity, based on market values. (Its D/S ratio is 0.25.) The risk- free rate is 6% and the market risk premium, rM - rRF, is 5%. Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%. What would be Simon's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?

• A) 13.00%
• B) 13.64%
• C) 14.35%
• D) 14.72%
• E) 15.60%

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Definitions:

Average Variable Cost

The average amount of variable cost per unit, calculated by dividing total variable costs by the quantity of output.

Profit-Maximizing

The approach taken by an enterprise to ascertain the optimal price and output quantity for the highest profit.

MR = MC

A principle in economics stating that profit maximization occurs when marginal revenue equals marginal cost.

Perfectly Competitive Market

An economic theory describing a market where no individual buyers or sellers have the power to influence the price of a product, and where the products offered are homogenous, with no barriers to entry or exit for businesses.