The common stock and debt of Northern Sludge are valued at $65 million and $35 m

Question

The common stock and debt of Northern Sludge are valued at $65 million and $35 million, respectively. Investors currently require a 15.9% return on the common stock and a 7.8% return on the debt. If Northern Sludge issues an additional $14 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.) New return on equity ___________%

Explanation / Answer

Hi, Please find the answers as follows: Expected Return on Assets = .078*35/100 + .159*65/100 = 13.065 or 13.06% New Return on Equity = .1306 + (35-14)/(65+14)*(.1306 - .078) = 14.45% Thanks.

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