.8 = (.25 x 0) + (.75 x β
True (as long as the return earned by the company is greater than
the interest payment, earnings per share increase, but the PyE falls
the higher risk).
False (the cost of equity increases with the ratio D/E).
False (the formula r
) does not require r
False (debt amplifies variations in equity income).
False (value increases only if clientele is not satisfied).
= .15, r
= .6 (unchanged), β
= .3, β
See Figure 13.3.
= .14, or 14%. From proposition 2 the leverage causes r
increase to r
)(D/E) = .14 + (.14 - .095) X (45/55) = .1768, or
After-tax WACC = .095 X (1 - .40) X .45 + .1768 X .55 = .1229, or 12.29%.
The two firms have equal value; let V represent the total value of
Rosencrantz could buy one percent of Company B’s
equity and borrow an amount equal to:
) = 0.002V
This investment requires a net cash outlay of (0.007V) and provides
a net cash return of:
(0.01 Profits) – (0.003 r
is the risk-free rate of interest on debt.
Thus, the two
investments are identical.