Rhatigan Corporation is based in Wichita. Approximately 45% of its sales are from exports to Canada, and the company has no other international business. It finances its operations with 35% dollar-denominated debt and 65% equity. Rhatigan Corporation borrows its funds from a U.S. bank at an interest rate of 7.5 percent per year. The long-term risk-free rate in the U.S. is 4 percent, whereas the long-term risk-free rate in Canada is 5.5% percent. The stock market return in the U.S. is expected to be 10 percent annually. Rhatigan uses a Beta of 0.85 for its stock. Its earnings are subject to a 32% corporate tax rate.

a. (8 points) What is the cost of capital for the Rhatigan Corporation?

b. (6 points) Suppose that the corporate tax rate rises to 40%. In response, the Rhatigan Corporation changes its capital structure to 40% debt and 60% equity. Assuming nothing else changes, what is the new cost of capital for the Rhatigan Corporation after these changes?