Assume markets are “perfect” asdescribed in Chapter 17. Firm U and Firm L have the exact sameassets (managed in exactly the same way). Firm U has no debt. Themarket value of Firm U’s equity is $10,000. Firm L has risk-freeperpetual debt with a market value of $4000 and equity with amarket value of $6000. Therefore, the market values of Firm U andFirm L are both $10,000. More information:

Expected return for Firm U’s assets =15% (since Firm U is all equity, the expected return for Firm U’sequity is also 15%)

Expected return for Firm L’s assets =15%

Expected return for Firm L’s debt =4%

What is the expected return for FirmL’s equity?

A. 17.75% B. 19.71% C. 20.00% D. 22.33%

E. 31.50% F. 35.00% G. 40.67% H. 59.00%

______    4.      Refer back to the previousproblem, but now assume that the expected return for Firm L’s debtis 5% instead of 4%. Keeping all the other facts the same, how willthis change in the expected return of Firm L’s debt affect theexpected return for Firm L’s equity?

A. The expected return for Firm L’sequity will be higher than the correct answer to the previousquestion.

B. The expected return for Firm L’sequity will be lower than the correct answer to the previousquestion.

C. The expected return for Firm L’sequity will be equal to the correct answer to the previousquestion.