Johnson Tire Distributors has an unlevered cost of capital of 10 percent, a tax rate of 33 percent, and expected earnings before interest and taxes of $1,900 in perpetuity. The company has $3,200 in bonds outstanding that have an 8 percent coupon and pay interest annually in perpetuity. The bonds are selling at par value. What is the cost of equity?
HINT: First get the value of the unlevered firm. Then get the value of the levered firm. Next, get the debt-equity ratio so you can calculate the cost of equity. Here you need both M&M propositions.
7.28 percent
10.41 percent
6.24 percent
9.36 percent
8.32 percent