Suppose a firm has a cost of equity of 12%, a D/E ratio of 1/6, and the YTM on its bonds is 7.5%. The risk-free rate is currently 3%. What is the current required rate of return on its assets and equity if the D/E ratio is changed to 1/3? (Round the answer to one decimal place of percentage.)
A) 11.35% and 13.25%
B) 11.35% and 8.25%
C) 13.25% and 11.35%
D) None of the above

Question

Quizplus · Accepted Answer

The required rate of return on assets (Ra) and equity (Re) when the D/E ratio changes can't be directly determined with the given information without applying the Modigliani-Miller proposition or a similar financial model to account for the effects of leverage. The provided data does not allow for a straightforward calculation without making additional assumptions about the tax rate, the cost of debt remaining constant with changes in the D/E ratio, and the application of a specific formula to calculate Ra and Re under the new D/E ratio.

Suppose a Firm Has a Cost of Equity of 12