A levered firm has only 2 assets on its balance sheet with the below market...
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Finance
A levered firm has only 2 assets on its balance sheet with the below market values and CAPM betas. The risk free rate is 3% pa and the market risk premium is 5% pa. Assume that the CAPM is correct and all assets are fairly priced.
| Selected Company Details | ||
| Item | Market value ($m) | Beta |
| Cash asset | 0.5 | 0 |
| Truck asset | 0.5 | 2 |
| Loan liabilities | 0.25 | 0.1 |
| Equity funding | ? | ? |
The firm then raises $1.5m more cash by writing more loans. Assume that the beta and yield on the new and existing loan liabilities are equal and unchanged compared to before. Ignore interest tax shields. All figures are given to 6 decimal places. Which of the following statements is NOT correct? This event led to a:
Select one:
a. $1.5m increase in loan liabilities to $1.75m and cash to $2m.
b. Asset beta of 0.4 and required return (or WACC before tax) of 5% pa.
c. Equity beta of 1.1 and required return of 8.5% pa.
d. $1.50 share price increase assuming that there are 1 million shares.
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