A company is currently all-equity financed with a cost of equity of 8%.

A company is moving from all-equity to a geared structure (D:E = 1:2) with corporate tax.

Using Modigliani & Miller with tax:

ke=ke0+(ke0−kd)(1−T)DEk_e = k_{e0} + (k_{e0} - k_d)(1-T)\frac{D}{E}ke​=ke0​+(ke0​−kd​)(1−T)ED​

Where:

ke0=8%k_{e0} = 8\%ke0​=8% (ungeared cost of equity)

kd=4%k_d = 4\%kd​=4%

T=30%T = 30\%T=30%

D/E=1/2=0.5D/E = 1/2 = 0.5D/E=1/2=0.5

ke=8%+(8%−4%)×0.7×0.5=8%+4%×0.35=8%+1.4%=9.4%k_e = 8\% + (8\% - 4\%) \times 0.7 \times 0.5 = 8\% + 4\% \times 0.35 = 8\% + 1.4\% = 9.4\%ke​=8%+(8%−4%)×0.7×0.5=8%+4%×0.35=8%+1.4%=9.4%

Answer: A. 9.4%