A)

Consider an ideal Modigliagni-Miller setting (i.e., perfect financial market, no bankrupt costs, no taxes).

Fiolty Group operates in this world. It is all-equity financed. Its expected yearly income (i.e., free cash flow) is $248. The actual income fluctuates from year to year. Given the risk associated with the income, equity investors require a return rate of 10%.

Now the company wants to replace part of its equity with debts. It will do so by issuing some perpetual bonds. The expected annual interest payment is $89, but the actual payment may fluctuate due to default risks (or postponement of payments). Given the risk of the bonds, bond holders require a return rate of 7%.

After the restructuring, the return rate of Fiolty Group's equity is ______% (remember to enter your answer as a percentage point).

B)

onsider an ideal Modigliagni-Miller setting (i.e., perfect financial market, no bankrupt costs, no taxes).

Fiolty Group operates in this world. It is all-equity financed. Its expected yearly income (i.e., free cash flow) is $212. The actual income fluctuates from year to year. Suppose standard deviation of the annual income is $59.

Now the company wants to replace part of its equity with debts. It will do so by issuing some perpetual bonds. The expected annual interest payment is $51, but the actual payment may fluctuate due to default risks. Suppose the standard deviation of annual interest payment is $4

The increase in the Sharpe ratio of the equity returns is ______ (remember to enter your answer as a decimal).