Assume an M&M world with taxes where the corporate tax rate is 25%, th

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%

ANSWER

A
Explanation: A) Ke = Ku + (Ku – Kd)(1-t)(D/E) = 12% + (12% – 8%)(1-.25 )*(.20/.80 ) = 12.75%.