A consultant has collected the following information regardi

A consultant has collected the following information regarding Young Publishing:

Total assets            $3,000 million                                Tax rate                                40%

Operating income (EBIT)              $800 million         Debt ratio                              0%

Interest expense                             $0 million        WACC                                   10%

Net income                                        $480 million          M/B ratio                                1.00×

Share price                                         $32.00                 EPS = DPS                            $3.20

The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20 percent debt and 80 percent equity (based on market values) that the cost of equity will increase to 11 percent and that the pre-tax cost of debt will be 10 percent. If the company makes this change, what would be the levered cost of equity? (The answers are in millions.)

Solution

The levered cost of equity is 11%, as when the capital structure changed to 20% debt and 80% equity, the cost of equity increased to 11%, ,

So the ans is option 3 - 11%