Problem:
Suppose that firm A is considering entering a business similar to firm B, a relatively small firm in a single line of business. Firm A is currently financed with 65 % debt and 35 % equity. Firm B, the pure-play firm, has a ? of 0.85 and is financed with 45% debt and 55 % equity. Firm B's marginal tax rate is 34 % and firm A's marginal tax rate is 39 %.
Required:
Question: If the riskless rate is 3 % and the market return is 8 %, estimate firm A's cost of equity for the new business using the CAPM.
Note: Please show how to work it out.