Archimedes Levers is financed by a mixture of debt and equity. You have the foll

Question

Archimedes Levers is financed by a mixture of debt and equity. You have the following information about its cost of capital: Return on debt = 14% Equity beta = 2.5 Risk-free rate of interest = 12% Expected return on market portfolio = 16% Debt rate = 0.6 Suppose now that Archimedes repurchases debt and issues equity so that D/V = 0.40. The reduced borrowing causes rD to fall to 13%. ------------------------------------------------------------ Calculate: A)Return on equity B) Return on asset C) Debt beta

Explanation / Answer

Hi, if you like my answer please rate me life-saver first. a) Return on equity = 12% + 2.5 * (16% - 12%) = 22% b) D/E = 0.4 debt weight = 0.4/1.4 = 0.2857 equity weight = 1/1.4 = 0.7143 Return on asset = 0.2857 * 13% + .7143 * 22% = 19.43% c) let debt's beta be A so 13% = 12% + A *(16%-12%) or A = 0.25

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