Question

question 4

Suppose CAPM holds, and the beta of the equity of your company is 2.42. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 6.75% and the risk-free rate is 3.50%. Suppose the debt-to-equity ratio of your company is 30% and the market believes that probability of default on your debt is zero. What is the percentage return on assets of your business? (No more than two decimals in the percentage but do not enter the % sign.)

Please show work

Answer 1

Return on the capital will be calculated using Capital Asset pricing model -

Return on equity=risk free rate+beta (market rate of interest-risk free rate)

= 3.50+2.42(6.75)

= 19.835%

It is given that the debt capital is 30% of the overall proportion of the capital structure.

Since there is no information about the the cost of debt or rate of taxation applicable, we cannot be calculating the overall return on the capital.

Return the Asset can only be estimated,

= 19.83%

if we can assume that we can put out the debt structure out of the overall return on capital then

= 19.83*70%

= 13.88%