Compaq is trying to estimate a cost of capital to use in assessing its entry into the high-end workstation market. The publicly traded firms in this market have an average beta of 1.20 and an average debt/equity ratio of 20%. There is intense competition within the industry for business. Compaq itself has a beta of 1.45 and has a leverage ratio of only 10%. It plans to maintain this debt ratio on its new venture. The T-Bond rate is 7%, the market risk premium is 5.5%, and the company's (before-tax) cost of debt is 7.5%. All firms' tax rate is 36%. What would be an appropriate estimate for the cost of capital for this new venture?

ANSWER: 12.42%

Can you explain the working? Thanks!