CHAPTER_17 - CHAPTER 17 Does Debt Policy Matter? Answers to...

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CHAPTER 17 Does Debt Policy Matter? Answers to Problem Sets 2. a. 5 5 . 5 . × + E r % = 12.5%; E r = 20% b. 12.5% c. E/P = 20%; P/E = 5 d. $50 e. .5 X E β + .5 X 0 = 1.0; E = 2.0. 3. Expected return on assets is r A = .08 X 30/80 + .16 X 50/80 = .13. The new return on equity will be r E = .13 + (20/60)(.13 - .08) = .147. 5. a. True b. True (as long as the return earned by the company is greater than the interest payment, earnings per share increase, but the PyE falls to reflect the higher risk). c. False (the cost of equity increases with the ratio D/E). d. False (the formula r E = r A + (D/E)(r A - r D ) does not require r D to be constant). e. False (debt amplifies variations in equity income). f. False (value increases only if clientele is not satisfied). 6. a. r A = .15, r E = .175 b. β A = .6 (unchanged), β D = .3, β E = .9. 8. Currently r A = r E = .14, or 14%. From proposition 2 the leverage causes r E to increase to r E = r A + (r A – r D After-tax WACC = .095 X (1 - .40) X .45 + .1768 X .55 = .1229, or 12.29%.
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This note was uploaded on 05/09/2011 for the course FNAN 522 taught by Professor Wilson during the Spring '11 term at University of Louisiana at Lafayette.

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CHAPTER_17 - CHAPTER 17 Does Debt Policy Matter? Answers to...

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