10. Simon Software Co. is trying to estimate its optimal capital structure. Right now, Simon has a capital structure that consists of 20 percent debt and 80 percent equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 6 percent and the market risk premium, rM rRF, is 5 percent. Currently the companys cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 25 percent.

What would be Simons estimated cost of equity if it were to change its capital structure to double its proportion of debt to 40 percent, leaving 60 percent equity? (Hints: solve for beta using CAPM, then use Hamada equation to solve for unlevered beta, then use that equation again to find the new levered beta, then use CAPM to find new cost of equity. Whew!)