Consider a simple firm that has the following market value balance sheet: Assets $1,030 | Liabilities & Equity Debt Equity 610 $420 Next year, there are two possible values for its assets, each equally likely: $1,190 and $970. Its debt will be due with 5.2% interest. Because all of the cash flows from the assets must go to either 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 41% in the firm's debt and 59% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's pre-tax WACC is the same as the expected return on its assets. If the assets will be worth $1,190 in one year, the expected return on assets will be %. (Round to one decimal place.) If the assets will be worth $970 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 41% debt and 59% equity, the expected return on the debt will be %. (Round to one decimal place.) If the equity will be worth $748.16 in one year, the expected return on equity will be If the equity will be worth $528.16 in one year, the expected return on equity will be %. (Round to one decimal place.) %. (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 41% debt and 59% 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 $1,030 | Liabilities & Equity Debt Equity 610 $420 Next year, there are two possible values for its assets, each equally likely: $1,190 and $970. Its debt will be due with 5.2% interest. Because all of the cash flows from the assets must go to either 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 41% in the firm's debt and 59% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's pre-tax WACC is the same as the expected return on its assets. If the assets will be worth $1,190 in one year, the expected return on assets will be %. (Round to one decimal place.) If the assets will be worth $970 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 41% debt and 59% equity, the expected return on the debt will be %. (Round to one decimal place.) If the equity will be worth $748.16 in one year, the expected return on equity will be If the equity will be worth $528.16 in one year, the expected return on equity will be %. (Round to one decimal place.) %. (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 41% debt and 59% equity will be %. (Round to one decimal place. There may be a slight difference due to rounding.)
