Please Help!!!!! Leverage and Capital Costs. Afirm currently has a debt-equity r

Question

Please Help!!!!!   Leverage and Capital Costs. Afirm currently has a debt-equity ratio of 1/2. The debt, which isvirtually riskless, pays an interest rate of 6 percent. Theexpected rate of return ont he equity is 12 percent. What wouldhappen to the expected rate of return on equity if the firm reducedits debt-equity ratio to 1/3? Assume the firm pays no taxes. Please Help!!!!!   Leverage and Capital Costs. Afirm currently has a debt-equity ratio of 1/2. The debt, which isvirtually riskless, pays an interest rate of 6 percent. Theexpected rate of return ont he equity is 12 percent. What wouldhappen to the expected rate of return on equity if the firm reducedits debt-equity ratio to 1/3? Assume the firm pays no taxes.

Explanation / Answer

Debt Equity ratio   = ½ (or) 0.50(50%)

Risk-free Interest rate = 6%

Expected rate of return on the equity = 12%

If the firm reduced its debt-equity ratio to 1/3(0.33)

Expected rate of return on the equity = 0.06 /0.33

Expected rate of return on the Equity = 0.1818 (or)18.18%

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