Tinko Ltd is a small business with assets valued at $1.5 million. The company uses both debt and equity to finance its operations. The company currently has a loan of $0.5 million with an interest rate of 8% per annum. The companys cost of equity has been estimated at 21.5% and its manager is considering a proposal to borrow a further $0.25 million which would be used to repurchase shares. The interest rate on the new loan is also 8% per annum. Assume MMs assumptions hold.

Use MMs Proposition 2 to calculate the effect of the increase in leverage on the cost of equity

Calculate the companys weighted average cost of capital before and after the increase in leverage. Comment on your results.