Consider a simple firm that has the following market-value balance sheet: Assets Liabilities & Equity $1,030 Debt $410 Equity 620 Next year, there are two possible values for its assets, each equally likely: $1,190 and $970. 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 %. (Round to one decimal place.) If the assets will be worth $970 in one year, the expected return on assets will be %. (Round to one decimal place.) The expected return on assets will be %. (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 $759.09 in one year, the expected return on equity will be %. (Round to one decimal place.) If the equity willl be worth $539.09 in one year, the expected return on equity will be %. (Round to one decimal place.)
Consider a simple firm that has the following market-value balance sheet: Assets Liabilities & Equity $1,030 Debt $410 Equity 620 Next year, there are two possible values for its assets, each equally likely: $1,190 and $970. 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 %. (Round to one decimal place.) If the assets will be worth $970 in one year, the expected return on assets will be %. (Round to one decimal place.) The expected return on assets will be %. (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 $759.09 in one year, the expected return on equity will be %. (Round to one decimal place.) If the equity willl be worth $539.09 in one year, the expected return on equity will be %. (Round to one decimal place.)
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
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Transcribed Image Text:Consider a simple firm that has the following market-value balance sheet:
Assets
Liabilities & Equity
Debt
Equity
$1,030
$410
620
Next year, there are two possible values for its assets, each equally likely: $1,190 and $970. 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 invested 40% in the firm's debt and 60% in its
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
equity will have the same expected return as the assets of the firm. That is, show that the firm's WACCi
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 %. (Round to one decimal place.)
If the assets will be worth $970 in one year, the expected return on assets will be %. (Round to one decimal place.)
The expected return on assets will be %. (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 $759.09 in one year, the expected return on equity will be %. (Round to one decimal place.)
If the equity will be worth $539.09 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.)
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