M&M Proposition 2: Bellamee Ltd has a required rate of return on its assets of 12% and a cost of debt of 6.25%. Their current debt-to-equity ratio is 1/5. What is the required rate of return on their equity?
A) 12.15%
B) 13.15%
C) 14.15%
D) 10.4%

Question

Quizplus · Accepted Answer

According to M&M Proposition 2, the required rate of return on equity (Re) is given by the formula: 
Re = R0 + (R0 - Rd) × (D/E)
where, R0 = Required rate of return on assets, Rd = Cost of debt, and (D/E) = Debt-to-equity ratio.
Substituting the given values, we get: 
Re = 12% + (12% - 6.25%) × (1/5) 
Re = 13.15%
Hence, the required rate of return on equity is 13.15%.

M&M Proposition 2: Bellamee Ltd Has a Required Rate of Return