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El Capitan Foods has a capital structure of 36% debt and 64% equity, its tax rate is 25%, and its beta (leveraged) is 1.25. Based

El Capitan Foods has a capital structure of 36% debt and 64% equity, its tax rate is 25%, and its beta (leveraged) is 1.25. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU?

a. 0.98
b. 0.54
c. 0.80
d. 1.10
e. 0.88

Firm A is very aggressive in its use of debt to leverage up its earnings for common stockholders, whereas Firm NA is not aggressive and uses no debt. The two firms' operations are identical--they have the same total investor-supplied capital, sales, operating costs, and EBIT. Thus, they differ only in their use of financial leverage (wd). Both companies are small, so they are not subject to the interest deduction limitation. Based on the following data, how much higher or lower is A's ROE than that of NA, i.e., what is ROEA - ROENA? Do not round your intermediate calculations.

Applicable to Both Firms Firm A's Data Firm NA's Data
Capital $240,000 wd 50% wd 0%
EBIT $40,000 Int. rate 12% Int. rate 10%
Tax rate 25%
a. 7.25 p.p.
b. 4.67 p.p.
c. 12.50 p.p.
d. -4.50 p.p.
e. 3.50 p.p.

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