Farah’s Fashions (FF) is expected to have free cash flow in the coming year of $8...

Farah’s Fashions (FF) is expected to have free cash flow in the coming year of $8 million which is expected to grow at 3% annually (in perpetuity). FF’s cost of equity is 13%, cost of debt is 7%, D/E ratio is 0.5, and its tax rate is 35%. What is the required return on firm assets (round to tenth of percent)?

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Expert Solution

Cost of debt after-tax=7*(1-tax rate)

=7*(1-0.35)=4.55%

Debt equity ratio=debt/equity

Hence debt=0.5*equity

Let equity be $x

Debt=$0.5x

Total=$1.5x

Required return on assets=Respective cost*Respective weight

=(x/1.5x*13)+(0.5x/1.5x*4.55)

=10.2%(Approx)

jeff jeffy answered 1 year ago

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