7.12 HiFlyer Corporation currently has no debt. Its tax rate is 0.4, and its unlevered beta is estimated by examining comparable companies to be 2.0. The 10-year bond rate is 6.25%, and the historical risk premium over the riskfree rate is 5.5%. Next year, HiFlyer expects to borrow up to 75% of its equity value to fund future growth.

a. Calculate the firm’s current cost of equity. Answer: 17.25%

b. Estimate the firm’s cost of equity after the firm increases its leverage to 75% of equity. Answer: 22.2%