Problem:
Cyclone Software Co. is trying to establish its optimal capital structure. Its current capital structure consists of 35% debt and 65% equity; however, the CEO believes the firm should use more debt. The risk-free rate, rRF, is 6%; the market risk premium, RPM, is 5%; and the firm's tax rate is 40%. Currently, Cyclone's cost of equity is 15%, which is determined by the CAPM.
Required:
Question: What would be Cyclone's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity?
Note: Provide support for your underlying principle.