Consider a simple firm that has the following market-value balance sheet: Assets Liabilities & Equity $1,000 Debt $400 Equity 600 Next year, there are two possible values for its assets, each equally likely: $1,190 and $960. Its debt will be due with 5.1% interest. Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 40% in the firm's debt and 60% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's WACC is the same as the expected return on its assets. If the assets will be worth $1,190 in one year, the expected return on assets will be 19 %. (Round to one decimal place.) If the assets will be worth $960 in one year, the expected return on assets will be -4%. (Round to one decimal place.) The expected return on assets will be 7.5 %. (Round to one decimal place.) For a portfolio of 40% debt and 60% equity, the expected return on the debt will be %. (Round to one decimal place.) If the equity will be worth $769.60 in one year, the expected return on equity will be %. (Round to one decimal place.) If the equity will be worth $539.60 in one year, the expected return on equity will be %. (Round to one decimal place.) The expected return on equity will be %. (Round to one decimal place.) The expected pre-tax return on a portfolio of 40% debt and 60% equity will be %. (Round to one decimal place. There may be a slight difference due to rounding.)
Consider a simple firm that has the following market-value balance sheet: Assets Liabilities & Equity $1,000 Debt $400 Equity 600 Next year, there are two possible values for its assets, each equally likely: $1,190 and $960. Its debt will be due with 5.1% interest. Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 40% in the firm's debt and 60% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's WACC is the same as the expected return on its assets. If the assets will be worth $1,190 in one year, the expected return on assets will be 19 %. (Round to one decimal place.) If the assets will be worth $960 in one year, the expected return on assets will be -4%. (Round to one decimal place.) The expected return on assets will be 7.5 %. (Round to one decimal place.) For a portfolio of 40% debt and 60% equity, the expected return on the debt will be %. (Round to one decimal place.) If the equity will be worth $769.60 in one year, the expected return on equity will be %. (Round to one decimal place.) If the equity will be worth $539.60 in one year, the expected return on equity will be %. (Round to one decimal place.) The expected return on equity will be %. (Round to one decimal place.) The expected pre-tax return on a portfolio of 40% debt and 60% equity will be %. (Round to one decimal place. There may be a slight difference due to rounding.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Concept explainers
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Topic Video
Question
Transcribed Image Text:Consider a simple firm that has the following market-value balance sheet:
Assets
Liabilities & Equity
$1,000
Debt
$400
Equity
600
Next year, there are two possible values for its assets, each equally likely: $1,190 and $960. Its debt will be due with 5.1% interest. Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the
debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 40% in the firm's debt and 60% in its equity will have the same
expected return as the assets of the firm. That is, show that the firm's WACC is the same as the expected return on its assets.
If the assets will be worth $1,190 in one year, the expected return on assets will be 19 %. (Round to one decimal place.)
If the assets will be worth $960 in one year, the expected return on assets will be
4%. (Round to one decimal place.)
-
The expected return on assets will be 7.5 %. (Round to one decimal place.)
For a portfolio of 40% debt and 60% equity, the expected return on the debt will be %. (Round to one decimal place.)
If the equity will be worth $769.60 in one year, the expected return on equity will be
%. (Round to one decimal place.)
If the equity will be worth $539.60 in one year, the expected return on equity will be
%. (Round to one decimal place.)
The expected return on equity will be %. (Round to one decimal place.)
The expected pre-tax return on a portfolio of 40% debt and 60% equity willI be
%. (Round to one decimal place. There may be a slight difference due to rounding.)
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education