9.11

A frim has an expected rate of return of 6%. Its debt trades for the risk-free interest rate of 3%. The prevailing equity premium is 4%.

1. If the expected rate of return on the firms equity is 7%, what is the firms debt ratio?

2. The firm refinances itself. It repurchases one-third or its stock with debt that it issues. Assume that his debt is still risk-free. What is its new debt ratio?

3. What expected rate of return does the firm have to offer to its new creditors?

4. Has the firms weighted average cost of capital changed?

5. What expected rate of return does the firm have to offer to its new levered equity holders?