SocksOnline is an Internet company that sells socks online. If the risk-free rate is 4.2% and the market risk premium is 7.1% answer the following problems:
a. The company has a beta of 1.6 and no debt. What is the cost of equity?
b. If the company decides to use 40% debt what is the new cost of equity? Note, the company's marginal tax rate is 35%. (Hint: find out the levered beta and then re-find out the cost of equity with that.)
c. Why is the cost of equity higher when debt is used?