We want to determine cost of equity for Firm A. We know that Firm A’s target debt-to equity ratio is 2.00. We also know that there is a comparable firm which has exactly same lines of business and therefore is expected to have the same level of business risk as Firm A. The equity beta of the comparable firm is known to be 1.20. The market value of equity and the market value of debt of the comparable firm are $200 million and $200 million, respectively. The corporate tax rate is 20%. Based on the information given, answer following questions.
(a) What would be your estimate of equity beta of Firm A if it does not have any financial leverage?
(b) What would be your estimate of equity beta of Firm A at its target capital structure?