A Firm Has Zero Debt in Its Capital Structure and Has

question 32

Multiple Choice

A firm has zero debt in its capital structure and has an overall cost of capital of 10 percent.The firm is considering a new capital structure with 60 percent debt at an interest rate of 8 percent.Assuming there are no taxes or other imperfections,what would be the cost of equity with the new capital structure?

• A)9 percent
• B)10 percent
• C)13 percent
• D)14 percent
• E)11 percent

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Definitions:

Stripped Bond

A debt security where the principal and regular coupon payments have been separated and are sold as individual securities.

Inflation Premium

The part of the nominal interest rate that represents compensation to the lender for the loss of purchasing power due to inflation.

Fisher Effect

An economic theory stating that the real interest rate is independent of monetary measures, especially the nominal interest rate and the expected inflation rate.

Canada Plus Call

Call provision that compensates bond investors for interest differential, making it unattractive for an issuer to call a bond.