Suppose that firm A is considering entering a business similar to firm B, a relatively small firm in a single line of business. Firm A is currently financed with 65 % debt and 35 % equity. Firm B, the pure-play firm, has a of 0.85 and is financed with 45% debt and 55 % equity. Firm Bs marginal tax rate is 34 % and firm As marginal tax rate is 39 %. If the riskless rate is 3 % and the market return is 8 %, estimate firm As cost of equity for the new business using the CAPM.

Check Answer: Firm As Cost of Equity = 8.89%