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3. There are two firms operating in the same industry with identical assets (i.e. they have the same return on assets and operational risk): No-Debt

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3. There are two firms operating in the same industry with identical assets (i.e. they have the same return on assets and operational risk): No-Debt Co. and All-In Co. No-Debt Co. is an all-equity financed firm and has an equity beta of 0.6. Risk-free rate is 4% and market risk premium is 10%. Both companies do not pay any taxes. a. What is the required rate of return on equity for No-Debt Co.? b. What would be the required rate of return on equity for No-Debt Co., if company issued risk-free debt with a market value equal to its current market value of equity to expand its current business? (Assume return on assets of company does not change after expansion.) c. All-In Co. has a Debt-to-Equity ratio of 9. Since the company is highly levered, investors consider its debt to be risky and consider beta of the company's debt to be 0.5. What must be the cost of equity for All-In Co.? (Hint: Consider using CAPM equation to determine the required rate of return on risky debt.)

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