A Firm Has Zero Debt in Its Capital Structure

question 31

Multiple Choice

A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The firm is considering a new capital structure with 50% debt. The interest rate on the debt would be 5%. Assuming that the corporate tax rate is 40%, its cost of equity capital with the new capital structure would be?

• A) 9.8%
• B) 9.2%
• C) 11%
• D) None of the above

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Definitions:

Inflation

The rate at which the general level of prices for goods and services is rising.

Holding-Period Return

The total return received from holding an asset or portfolio of assets over a period of time, considering both price appreciation and dividends or interest.

Dividend

Payments made by a corporation to its shareholders, usually as a distribution of profits.

Annual Real Rate

The annual rate of return on an investment, adjusted for inflation, indicating the real purchasing power increase over the investment period.