Simon Software Co

question 6

Multiple Choice

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

• A) 14.35%
• B) 30.00%
• C) 14.72%
• D) 15.60%
• E) 13.64%

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Definitions:

Stock Prices

The cost of purchasing a share of equity in a company, which fluctuates based on market conditions.

Shares Outstanding

The total number of a company's shares that are currently owned by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company’s officers and insiders.

2-for-1 Split

A stock split in which a company divides its existing stock into two shares, effectively halving the price of each share while doubling the number of shares owned by shareholders.

5-for-3 Split

A type of stock split where shareholders receive 5 shares for every 3 shares they hold, effectively increasing the share quantity and adjusting the stock price downward.