Problem 2

Mass Inc. is trying to estimate its optimal capital structure. Right now, Mass Inc. has a capital structure that consists of 50 percent debt and 50 percent equity, based on market values. (Its D/S ratio is 1.00) The risk- free rate is 6 percent and the market risk premium, KM KRF, is 5 percent. Currently the companys cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent. What would be Mass Inc.s estimated cost of equity if it were to change its capital structure to 60 percent debt and 40 percent equity?