2. ABC Inc. is a levered company. The firm has $50 million bonds outstanding with an annual coupon rate of 4% and an YTM of 4%. It has 100 million shares outstanding with a price of $5 per share and a beta of 1.2. Corporate tax rate is assumed to be 40%. The risk rate is 2% and the expected return on the market portfolio is 10%. What is the firm’s cost of equity if the debt-to-equity ratio were 0?

To calculate the firm's cost of equity when the debt-to-equity ratio is 0, we need to consider the Capital Asset Pricing Model (CAPM).

The CAPM formula is as follows:

Cost of Equity = Risk-Free Rate + Beta * (Expected Market Return - Risk-Free Rate)

Let's break down the calculation step by step:

1. Risk-Free Rate: The question states that the risk-free rate is 2%.

2. Beta: The question provides the beta as 1.2. Beta measures the sensitivity of a stock's returns to the overall market returns. A beta of 1.2 indicates that the stock is expected to be 20% more volatile than the market.

3. Expected Market Return: The question states that the expected return on the market portfolio is 10%.

Now we can calculate the cost of equity:

Cost of Equity = 2% + 1.2 * (10% - 2%)
= 2% + (1.2 * 8%)
= 2% + 9.6%
= 11.6%

So, if the debt-to-equity ratio were 0, the firm's cost of equity would be 11.6%.