Question

Вопрос 4

Suppose CAPM holds, and the beta of the equity of your company is 2.33. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 6.00% and the risk-free rate is 3.25%. Suppose the debt-to-equity ratio of your company is 35% and the market believes that the beta of your debt is 0.30. What is return on assets of your business? (Allow two decimals in the percentage but do not enter the % sign.)

Answer 1

The formula for Expected Return On Assets is:

ERA = RFR + BOA (MRP)

where ERA = expected return on assets

RFR = risk-free rate

BOA = beta of the asset

MRP = market risk premium

First, we need to get the BOA

In the absence of tax rate, the BOA is = (BOE × DTER) ÷ BOD

where BOE = beta of equity

DTER = debt-equity ratio or debt to equity ratio

BOD = beta of debt

BOA = (2.33 × 0.35) ÷ 0.3

= 0.8155 ÷ 0.3 = 2.7183

Now,

ERA = 3.25% + 2.7183 (6%)

= 0.0325 + 2.7183 (0.06)

= 0.0325 + 0.1631

= 0.1956 or 19.56