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Consider a simple firm that has the following market value balance sheet: Assets Liabilities & Equity $1,040 Debt $410 Equity 630 Next year, there are
Consider a simple firm that has the following market value balance sheet: Assets Liabilities & Equity $1,040 Debt $410 Equity 630 Next year, there are two possible values for its assets, each equally likely: $1,180 and $950. Its debt will be due with 4.9% 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 39% in the firm's debt and 61% 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 $1,180 in one year, the expected return on assets will be %. (Round to one decimal place.) Consider a simple firm that has the following market value balance sheet: Assets Liabilities & Equity $1,040 Debt $410 Equity 630 Next year, there are two possible values for its assets, each equally likely: $1,180 and $950. Its debt will be due with 4.9% 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 39% in the firm's debt and 61% 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 $1,180 in one year, the expected return on assets will be %. (Round to one decimal place.)
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