Assume that: 1) firms stop their business in one year, 2) earnings before interest and taxes in
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Assume that: 1) firms stop their business in one year, 2) earnings before interest and taxes in one year are expected to be worth EBIT, 3) the corporate tax rate is Tc, 4) the cash-flow to debtholders in one year is expected to be IP + F, where IP is the expected interest payment, 5) the probability that the levered firm defaults in one year is p, and 6) bankruptcy costs are worth BC. Provide a formula for the cost of levered equity rS. The formula has to depend on: S, EBIT, Tc, IP, F, p, BC, rB, and r0 only.
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