Joes Manufacturing Company has $750 debt 
            outstanding with pretax cost of 6% and its common stock has a value 
            of $1,250. The required return on equity is 14.34%. The firm faces a 
            corporate tax rate of 35%. What is Monongahela's equivalent 
            unlevered cost of equity?

Fatima1102 ?

I hope that you?re reading these Answers in the order that they were
answered because the last question on Joe?s Manufacturing is critical
to answering this one:
http://answers.google.com/answers/threadview?id=566672

According to Proposition 2 of the M&M theorem, the value of the firm
stays the same and costs of capital shift, as follows:

rE = r0 + D/E*(1-Tc)*(r0 - rD)

rE is the cost of equity
rD is the cost of debt
r0 is the cost of capital for an all-equity firm
D is the debt level
E is the equity level
Tc is the corporate tax rate
rWACC is a firm?s weighted average cost of capital. In a world with no
taxes, rWACC for a levered firm is equal to rA.


WWWFinance
?M&M Proposition II,? (Harvey, Dec. 4, 1995)
http://www.duke.edu/~charvey/Classes/ba350/capstruc/capstruc.htm


JOE?S WITH DEBT
===============

Here?s what we know about Joe?s Manufacturing:

14.34% = r0 + $750/$1,250 * (0.65) * (r0 ? 6%)

14.34% = r0 + 0.39r0 ? 2.34%

16.68% = 1.39 r0

r0 = 12%

----
 
What?s important to remember here?  
1.	the value of the firm stays the same.
2.	your capital costs shift ? the cost of equity goes up because debt
is increasing the risk to shareholders (bond holders always get paid
first).  Also, the weighted-average cost-of-capital (WACC) goes down/
3.	the tax-deductibility of debt further reduces the WACC.



Google search strategy:
?Modigliani-Miller? proposition II

Best regards,

Omnivorous-GA