Business and Financial Risk assume a firms debt is risk free, so that the cost of debt equals the risk free rate, Rf Define A as the firms asset beta that is, the systematic risk of the firms assets Define E to be the beta of the firms equity Use the capital asset pricing model (CAPM) along with M ...

MM Proposition II with no taxes is R E R A R A R f DE Note that we use the r ...

Business and Financial Risk assume a firms debt is risk-free, so that the cost of debt equals

Question:

Business and Financial Risk assume a firm’s debt is risk-free, so that the cost of debt equals the risk-free rate, Rf Define βA as the firm’s asset beta-that is, the systematic risk of the firm’s assets. Define βE to be the beta of the firm’s equity. Use the capital asset pricing model (CAPM) along with M&M Proposition II to show that βE = βA x(1 + D/E), where D/E is the debt-equity ratio. Assume the tax rate is zero.

Capital Asset Pricing Model
The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. The CAPM is a model for pricing an individual security or portfolio. For individual securities, we make use of the security market line (SML) and its... Cost Of Debt
The cost of debt is the effective interest rate a company pays on its debts. It’s the cost of debt, such as bonds and loans, among others. The cost of debt often refers to before-tax cost of debt, which is the company's cost of debt before taking...