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13-8. HAMADA EQUATION Situational Software Co. (SSC) is trying to establish its optimal capital structure. Its current capital structure consists of 25% debt and 75% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, FRF, is 4%; the market risk premium, RPM, is 5%; and the firm's tax rate is 25%. Currently, SSC's cost of equity is 12%, which is determined by the CAPM. What would be SSC's estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? > Answer 1960% % PROBLEM 13-8 page 488 in your text book can be solved in four steps... 13-8 Facts as given: Current capital structure: 25% debt, 75% equity; TRE = 4%; Market Risk Premium=em - IRE = 5%; Tax rate=25%; r, under this current capital structure=12%. What would be the new cost of equity if the company changed its capital structure to 40% debt and 60% equity? Step 1: Determine the firm's current beta. =TR+ ('M - Fieb Step 2: Determine the firm's unlevered beta, bu. by = b/[1 + (1 - T)(D/E)] Step 3: Determine the firm's beta under the new capital structure. b = by[1 + (1 - 1)(D/E)] Step 4: Determine the firm's new cost of equity under the changed capital structure. F = TRE+ (rm-TRED