A firm currently has a debt-to-equity ratio of 1/2. Almost risk-free debt pays 6.9% interest rate. The expected return on

Question:

A firm currently has a debt-to-equity ratio of 1/2. Almost risk-free debt pays 6.9% interest rate. The expected return on equity is 11%. What happens to the expected rate of return on equity if the firm reduces the debt-to-equity ratio to 1/3? Suppose the firm does not pay taxes. (Do not round up intermediate calculations. Enter your answer as a percentage, rounded to 2 decimal places.)

Expert Answer:

Answer rating: 100% (QA)

To analyze the impact of reducing the debt to equity ratio on the expected rate of return on equity we need to calculate the new expected rate of retu

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