Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt. However, the CFO is considering moving to a capital structure with 30% debt and 70% equity. If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?

Answer:change in equity cost is  1.70% Step-by-step explanation:given data tax rate T = 40%beta b =  1.10debt D = 30%equity E = 70%risk-free rate RR = 5.0%risk premium RP = 6.0%to find outthe capital structure shift change the firm cost of equitysolutionwe know here debt and equity so Target D/E will be = [tex]\frac{30}{70}[/tex]     Target D/E = 0.43levered beta = beat ( 1 + D/E × (1 - tax rate) ) levered beta = 1.10 ( 1 + 0.43 × (1 - 40%) ) levered beta =  1.3828571   andcost of equity unlevered  = risk-free rate + beta (risk premium) cost of equity unlevered  = 5% + 1.1 (6%)  = 11.60%andcost of equity levered = risk-free rate + levered beta (risk premium)cost of equity levered = 5% + 1.38 (6%) =  13.30% so change in equity cost will be  =  13.30% - 11.60%change in equity cost is  1.70%