Carla and Bill currently have $700,000 in assets and $260,000 in liabilities. Their average cost of debt is fixed at 7%. (note: fixed cost of debt means there is no interest rate risk).

Their consumption and tax rates are 40% and 30% respectively. Taxes are based on returns to assets less interest expense. Suppose the expected rate-of-return on assets is 7.15% and the standard deviation for the rate-of-return on assets is 6.67%. Answer the following questions.

A.What is the expected rate of growth under risk?

B.What are the standard deviation and coefficient of variation of the expected rate of growth?

C.Now, suppose interest rates on debt are subject to unanticipated variability. The expected value and standard deviation of interest rates are 7% and 2%, respectively. The rate of return and interest rates are assumed to be statistically independent. Calculate the expected value, standard deviation, and coefficient of variation of the growth rate. (note: use the information from the original problem. All that has changed is that there is now both interest rate risk and risk associated with the return on assets and the interest rate.)