Assume an M&M world with taxes where the corporate tax rate is 25%, the before tax required return on debt is 8%, the required return on the unlevered firm is 12%, and the firm is financed 20% with debt and 80% with equity
What is the required return on equity?
A) 12.75%
B) 15.00%
C) 13.25%
D) 11.25%
A
Explanation: A) Ke = Ku + (Ku - Kd)(1-t)(D/E) = 12% + (12% - 8%)(1-.25 )*(.20/.80 ) = 12.75%.
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