Suppose that ABC Inc. has a leverage ratio (debt to asset) 0.5. It has a beta of 1.2. The risk-free rate is 6% and the market risk premium is 7%. The firm has a debt issue outstanding with 10 years to maturity that is quoted at 97 percent of face value. The issue makes semiannual payments and has a coupon rate of 10 percent annually. Assume that there is no tax.

a) Calculate the cost of capital for this company using MM theory

b) what is the new cost of equity if ABC Inc. changes the proportion of debt and equity so that the leverage ratio = 0.3 and cost of debt is 9%.