Question: HiFlyer Corporation does not currently have any debt. Its tax rate is .4 and its unlevered beta is estimated by examining comparable companies to be 2.0. The 10-year bond rate is 6.25%, and the historical risk premium over the risk-free rate is 5.5%. Next year, HiFlyer expects to borrow up to 75% of its equity value to fund future growth.
a. Calculate the firm's current cost of equity.
b. Estimate the firm's cost of equity after it increases its leverage to 75% of equity.