Consider a simple firm that has the following market value balance sheet: Assets $1,050 Liabilities & Equity Debt Equity $440 610 Next year, there are two possible values for its assets, each equally likely: $1,200 and $960. Its debt will be due with 5.2% interest. Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 42% in the firm's debt and 58% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's WACC is the same as the expected return on its assets. If the assets will be worth $1,200 in one year, the expected return on assets will be 0%. (Round to one decimal place.) If the assets will be worth $960 in one year, the expected return on assets will be %. (Round to one decimal place.) The expected return on assets will be %. (Round to one decimal place.) For a portfolio of 42% debt and 58% equity, the expected return on the debt will be %. (Round to one decimal place.) If the equity will be worth $737.12 in one year, the expected return on equity will be %. (Round to one decimal place.) If the equity will be worth $497.12 in one year, the expected return on equity will be %. (Round to one decimal place.) The expected return on equity will be %. (Round to one decimal place.) The expected pre-tax return on a portfolio of 42% debt and 58% equity will be %. (Round to one decimal place. There may be a slight difference due to rounding.) Consider a simple firm that has the following market value balance sheet: Assets $1,050 Liabilities & Equity Debt Equity $440 610 Next year, there are two possible values for its assets, each equally likely: $1,200 and $960. Its debt will be due with 5.2% interest. Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 42% in the firm's debt and 58% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's WACC is the same as the expected return on its assets. If the assets will be worth $1,200 in one year, the expected return on assets will be 0%. (Round to one decimal place.) If the assets will be worth $960 in one year, the expected return on assets will be %. (Round to one decimal place.) The expected return on assets will be %. (Round to one decimal place.) For a portfolio of 42% debt and 58% equity, the expected return on the debt will be %. (Round to one decimal place.) If the equity will be worth $737.12 in one year, the expected return on equity will be %. (Round to one decimal place.) If the equity will be worth $497.12 in one year, the expected return on equity will be %. (Round to one decimal place.) The expected return on equity will be %. (Round to one decimal place.) The expected pre-tax return on a portfolio of 42% debt and 58% equity will be %. (Round to one decimal place. There may be a slight difference due to rounding.)
