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Assuming that both expected bankruptcy costs and expected tax savings are strictly positive, provide a formula for the cost of levered equity rS. The formula
Assuming that both expected bankruptcy costs and expected tax savings are strictly positive, provide a formula for the cost of levered equity rS. The formula has to depend on: S0, S, B, T S, P VBC , rB, and r0 only. Hint: Use the fact that the expected return on a portfolio P invested in J securities is: rP = x1r1 + x2r2+, . . . , +xJ rJ , where r1, r2, r3, . . . are the expected returns of each security and x1, x2, x3, . . . the weights/fractions of the portfolio invested in each security.
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