A firms capital consists of 30% debt and 70% equity. The cost of debt is 7.5% and cost of equity is 15%.

a) Calculate the levered Beta if the unlevered Beta of the firm is 1.2?

b) Suppose that the firm changes its capital structure to 40% debt and 60% equity. Find the new E of the levered firm using your answer from part a, if the D =0.1?

(hint: use original debt and equity allocation with the beta of debt (mentioned in this part) and equity beta (from part a) to find firm's/asset beta. Then hold the firm's beta and debt beta constant, use new debt and equity ratios to find the new equity beta.)

c) Using formulas, examples and diagrams, illustrate the effect of debt on the value of a firm?