a. For Company LL (Low Leverage), the total assets is $20,000,000, Debt ratio is 30%, the

interest rate is 10%, tax rate is 40%, and EBIT is $4,000,000. Whats LLs return on equity

(ROE)? ROE = Net Income / Equity

Fro Company HL (High Leverage), the total assets is $20,000,000, Debt ratio is 50%, the interest rate is 12%, tax rate is 40%, and EBIT is $4,000,000. Whats HLs return on equity (ROE)?

b. IF Company LLs debt ratio is increased to 60% with interest rate of 15%, and other things remain unchanged as above, Whats LLs ROE? Will it be higher than HLs ROE? If not, why?

14-5 If Company ABCs current capital structure is: 25% debt, 75% equity; risk free rate of return

r_RF = 5%; market premium r_M r_RF = 6%; tax rate T = 40%; and cost of equity r_s = 14%,

1. Whats the Companys levered beta b?

2. Whats the Companys unlevered beta bu ?

3. If the Companys debt ratio becomes 50%, whats Companys new levered beta bL ?

4. Whats the Companys new cost of equity under the changed capital structure?

14-6 Company XYZ currently has zero debt, and is a zero growth company with the data shown below. If the company is planning using some debt with the debt ratio as indicated below, and the money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk from the additional leverage would cause the required rate of return on equity to rise, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACC_Old - WACC_New?

New Debt/Assets 55% Orig. cost of equity, r_s 10.0%

New Equity/Assets 45% New cost of equity = r_s 11.0%

Interest rate new = r_d 7.0% Tax rate 40%