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Alexus [3.1K]
3 years ago
8

Modigliani and​ Miller's world of no taxes. Roxy​ Broadcasting, Inc. is currently a​ low-levered firm with a​ debt-to-equity rat

io of ​/. The company wants to increase its leverage to ​/ for debt to equity. If the current return on assets is ​% and the cost of debt is ​%, what are the current and the new costs of equity if Roxy operates in a world of no​ taxes? What is the current cost of equity if Roxy operates in a world of no​ taxes?
Business
1 answer:
PSYCHO15rus [73]3 years ago
7 0

Answer and Explanation:

The computation is shown below:

For Current  

Total assets = Debt + Equity

= 2 + 7 9

Now

Debt ratio = Debt ÷ Total assets = 2 ÷ 9  

Equity ratio = Equity ÷ Total assets = 7 ÷ 9  

Return on assets = Cost of debt × Debt ratio + Cost of equity × Equity ratio

11% = 9% × 2 ÷ 9 + Cost of equity × 7 ÷ 9  

Cost of equity × 7 ÷ 9 = 11% - (9% × 2 ÷ 9)  

Cost of equity = ( 11% - (9% × 2 ÷ 9) ) × 9 ÷ 7

= 12%

For New  

Total assets = Debt + Equity = 7 + 2 = 9

Debt ratio = Debt ÷ Total assets = 7 ÷ 9  

Equity ratio = Equity ÷ Total assets = 2 ÷9  

Return on assets = Cost of debt × Debt ratio + Cost of equity × Equity ratio

11% = 9% × 7 ÷ 9 + Cost of equity × 2 ÷ 9  

Cost of equity × 2 ÷ 9 = 11% - (9% × 7 ÷ 9)  

Cost of equity = ( 11% - (9% × 7 ÷ 9) ) × 9 ÷ 2

= 18%

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The correct answer is option c.

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Answer:

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