Question $3(5$ points$)$

The Miller Modigliani theorem posits that debt policy is irrelevant, when it comes to firm value. Assume that you have a firm that is funded entirely with equity and has a beta $($unlevered$)$ of $0\mathrm{.}90$ ; the risk free rate is $3\%$ and the equity risk premium is $6\%.$ What will happen to the cost of capital, if the firm moves to a $20\%$ debt ratio? $($Remember that there are no taxes or default risk in the Miller Modigliani world$).$

The cost of capital will remain unchanged.

The cost of capital will go up$.$

The cost of capital will go down.