ABC Ltd pre-tax cost of debt is 12 %, Tax rate is 33 %, India market risk-free rate is 7 % and the market risk premium of general market is 8 %.
India's general market debt to equity is 1:1.
Investors assess ABC business risk and believe that ABC risk is 50% higher than general market. They believe that ABC should have a beta of 1.5 times to cover for its business risk.
ABC Ltd wants to increase debt to reduce its Cost of Capital. But investors also mention that with increased debt they will increase financial risk in business.
What is Nishant Ltd Cost of Capital under following circumstances:
A. If Debt to Equity is 1:2 - financial risk is 30% safer than general market
B. If Debt to Equity is 1:1 - financial risk is as per general market
C. If Debt to Equity is 2:1 - financial risk is 30% higher than general market.
What would you advise ABC to do - go for A, B or C and why?