A levered firm has only 2 assets on its balance sheet with the below-market values...
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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 pays off (retires) all of its loan liabilities using its cash. Ignore interest tax shields. Which of the following statements is NOT correct? All answers are given to 6 decimal places. This event led to a:
Select one:
a.
$0.25m decrease in loans to zero and cash to $0.25m.
b.
Rise in the asset beta to 1.333333 and required return on assets (or WACC before tax) to 9.666667% pa.
c.
Rise in the equity beta to 2 and required return on equity to 13% pa.
d.
Fall in the debt-to-assets ratio to zero.
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