9 Return on Equity Mayou plc currently has no debt in its capital structure but has decided to issue new debt to replace the equity so that the debt to equity ratio is 1:1. On the firm’s accounting statements, the total asset value is £120,000. Equity book and market values are the same and there are currently 300 shares outstanding. The coupon on the bonds is 10 per cent and the bond issue will be at par. Assume that there are three possible economic states: recession, expected and boom time. The earnings in each state are

£8,000, £10,000 and £12,000 respectively. Estimate the return on equity of Mayou plc in each state under the original capital structure and the capital structure including debt.