Answer:
14.35%
Explanation:
Simon Software Co
rs= 12%
D/E = 0.25
rRF= 6%
RPM= 5%
Tax rate = 40%.
We are going to find the firm’s current levered beta by using the CAPM formula which is :
rs = rRF+ RPM
12%= 6% + 5%
= 1.2
We are going to find the firm’s unlevered beta by using the Hamada equation:
=bU[1 + (1 −T)(D/E)]
Let plug in the formula
1.2= bU[1 + (0.6)(0.25)]
1.2=(1+0.15)
1.2= 1.15bU
1.2÷1.15
1.0435= bU
We are going to find the new levered beta not the new capital structure using the Hamada equation:
b= bU[1 + (1 −T)(D/E)]
Let plug in the formula
= 1.0435[1 + (0.6)(1)]
=1.0435(1+0.6)
=1.0435(1.6)
= 1.6696
Lastly we are going to find the firm’s new cost of equity given its new beta and the CAPM:
rs= rRF+ RPM(b)
Let plug in the formula
= 6% + 5%(1.6696)
= 14.35%
Simons estimated cost of equity is going to be 14.35 percent
To solve this problem, we have to make use of the formula below
rs = rRF + RPM(b)
Where rs = 12%
rRF = 6%
RPM = 5%
When we put these values into the formula we have;
12% = 6% + 5%b
We take like terms
5%b = 12%-6%
5%b = 6%
0.05b = 0.06
b = 0.06/0.05
= 1.2
The formula for b
b = bU[1 + (1 - T)(D/E)]
where 1-t = 0.6
D/E = 0.25
1.2 = bU[1 + 0.6*0.25]
1.2 = bU[1+0.15]
1.2 = 1.15bU
Divide through by 1.15
bU = 1.2/1.15
= 1.044
b = bU[1 + (1 - T)(D/E)]
We have to put in the value of bU into the formula above
b = 1.044[1 + 0.6]
b= 1.67
We have to put the value of b into the first equation
rs = 0.06+0.05(1.67)
= 0.06+0.0835
= 0.1435 * 100
= 14.35%
Simons estimated cost of equity is going to be 14.35 percent
Read more on https://brainly.com/question/23389895?referrer=searchResults
