Goodyear Enterprises is currently an all-equity firm with an expected return of 12.5%. Markets are perfect and there are no taxes. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. Suppose Goodyear borrows to the point that its debt-to-value ratio (i.e., D/(D+E)) is 0.35. With this amount of debt, the debt cost of capital is 5%. The expected return of equity after this transaction is closest to:

Answer

a. 15.13%

b. 13.13%

c. 16.54%

d. 17.54%