ABC company and XYZ company have identical assets and currently they both have a debtequity ratio of 1. Both companies have a cost of riskless debt of 4% and return on equity of 20%. Expected rate of return on market portfolio is 14% and firms are not subject to any taxes in this economy.

a) ABC company decides to change its debt-equity ratio to 0.5 by issuing equity and retiring debt. What is its cost of equity after capital restructuring?

b) XYZ company decides to change its debt-equity ratio to 2 by issuing debt and retiring equity. At this point, debt becomes risky and has a beta of 0.30. What is its cost of equity after capital restructuring? (Hint: You can use CAPM to estimate cost of risky debt)