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Assume perfect capital markets. Mezzanine Corp., of which you are the CFO, is currently financed 60% by equity and 40% by debt. Your expected free cash flow is $15 million per year and is expected to grow at a 5% annual rate forever. You estimate (based on your asset beta) that your assets should return approximately 15%. Your debt is risk-free and pays 7.5%. Ignore taxes. What is the expected return on equity of Mezzanine Corp.

Respuesta :

TomShelby

Answer:

return on equity 20%

Explanation:

The return on asset will be like the WACC of the company

thus, we have:

[tex]WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})[/tex]

with:

Ke x

Equity weight 0.6000

Kd 0.075

Debt Weight 0.4000

t 0 (ignore taxes)

with WACC = 0.15

[tex] 0.15 = K_e(0.6) + 0.075(1-0)(0.4)[/tex]

[tex]  K_e(0.6) = 0.15 - 0.075(1-0)(0.4)[/tex]

[tex]  K_e = ( 0.15 - 0.075(1-0)(0.4) ) / 0.6 [/tex]

Ke = 20%

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