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Why is the cost of equity higher when debt is used

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Question - 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 questions:

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: calculate the levered beta and then re-calculate the cost of equity with that.)

c. Why is the cost of equity higher when debt is used?

Reference no: EM131831684

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