Premium for Financial Risk Ethier Enterprise has an unlevered beta of 1.0. Ethier is financed with...

Premium for Financial Risk Ethier Enterprise has an unlevered beta of 1.0. Ethier is financed with 40% debt and has a levered beta of 1.4. If the risk free rate is 5.5% and the market risk premium is 4%, how much is the additional premium that Ethier's shareholders require to be compensated for financial risk? Round your answer to one decimal place. %

Expert Solution

R_f = 5.5%

Market risk premium (R_m - R_f) = 4%

beta = 1.4
(We consider levered beta in the Capital Asset Pricing Model)

Using CAPM,

Hence

Hence K_e = 11.1%

Additional premium required = k_e - R_f

which is equal to 11.1% - 5.5% = 5.6%

Hence additional premium required to compensate for financial risk is 5.6%

jeff jeffy answered 2 years ago

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