Problem:
Simon Software Co. currently has a capital structure that consists of 20 percent debt and 80 percent equity. (Its D/E ratio is 0.25.) The risk-free rate is 6 percent and the market risk premium, Rm - Rrf, is 5 percent. Currently the company's cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent.
Required:
What would be Simon's estimated cost of equity if it were to change its capital structure to 50 percent debt and 50 percent equity? (Hint: Use the Hamada equations.)
14.35%
30.00%
14.72%
15.60%
13.64%
Give explanation comprehensively and provide step by step solution.