Evil eye inc., a manufacturer of pendants and necklaces, is 30% debt financed. Its current equity beta is 1.1 and its debt beta is 0. The companys cost of debt is 6%, and its tax rate is 35%. The risk-free rate is 4%, and market risk premium is 7%.

1. What is the firms cost of capital under the current capital structure?
2. What is the firms cost of equity if the firm were 40% financed? Is it higher or lower than the firms current cost of equity? Why?