What is the expected return on equity for a tax-free firm with a 15% expected return on assets that pays 12% on its debt, which totals 25% of assets?

Question

Quizplus · Accepted Answer

The expected return on equity (ROE) can be calculated using the formula: ROE = Return on Assets + (Return on Assets - Cost of Debt) * (Debt/Equity). Given that the firm is tax-free, the formula simplifies to ROE = 15% + (15% - 12%) * (25%/75%) = 16%.

What Is the Expected Return on Equity for a Tax-Free