Question

Macbeth Spot Removers is entirely equity financed. Use the following information.

Data
Number of shares	2,700
Price per share	$44
Market value of shares	$118,800
Expected operating income	$17,820
Return on assets	15%

Macbeth now decides to issue $59,400 of debt and to use the proceeds to repurchase stock. Suppose that Ms. Macbeth's investment bankers have informed her that since the new issue of debt is risky, debtholders will demand a return of 10.8%, which is 3.2% above the risk-free interest rate.

a. What are r_A and r_E after the debt issue? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

Return on assets	%
Return on equity	%

b. Suppose that the beta of the unlevered stock was .60. What will β_A, β_E, and β_D be after the change to the capital structure? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Asset beta :
Debt beta :
Equity beta:

Answer 1

a. Return on Equity and Return on Assets

b. Asset Beta, Debt Beta, Equity Beta:

Please note the following formula:

   

where, T = Corporate Tax Rate

Since, we are not given any tax rate in the question, we can assume is to be zero.

Using the information given and applying the above formula, we can calculate the equity beta.

Unlevered Beta = 0.60

Equity = $ 59,400

Debt = $59,400

Calculating Equity Beta,

Therefore, Equity Beta = 1.20

Debt Beta:

Debt Beta is always considered to be zero, since, a company has to pay interest to its lenders at a fixed rate every year. Fixed interest payment doesn't get affected by any market or environmental changes and thus, it is not volatile to the market. Hence, debt beta will be zero.

Asset Beta:

Asset Beta is the unlevered beta of the company which is 0.60 as per the question.

Final Answers:

Asset Beta	0.60
Debt Beta	0
Equity Beta	1.20

I hope this helps. Please let me know in case of any concern.