Question

Hubbard’s Pet Foods is financed 90% by common stock and 10% by bonds. The expected return on the common stock is 13.9%, and the rate of interest on the bonds is 7.3%. Assume that the bonds are default-free and that there are no taxes. Now assume that Hubbard’s issues more debt and uses the proceeds to retire equity. The new financing mix is 63% equity and 37% debt.

Given the initial capital structure, calculate the expected return on assets. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Expected rate of return %

Given the revised capital structure, calculate the expected rate of return on equity. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected rate of return %

Answer 1

Ans.

For Initial capital structure

and we know that Expected return on assets is equals to = Expected ROE x WOE + Expected ROD x WOD

here,

ROE = return on equity

WOE = weight of equity

ROD = return on debt

WOD = weight of debt

                                                                                    = 13.9% x 90% + 7.3% x 10%

                                                                                    = 13.2%

For Revised capital structure ,

now here we know that expected rate of return on assets is 13.2%

             13.2% = Expected return on equity x 63% + 7.3% x 37%

Expected return on equity = 10.499% /63%

                                     = 16.667%

Please give us a thumbs up