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Consider a simple firm that has the following market-value balance sheet:

Assets		Liabilities & Equity
$ 1,020		Debt	$ 400
		Equity	620

Next year, there are two possible values for its assets, each equally likely: $1,190 and $ 970. Its debt will be due with 5.1% interest. Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as thefirm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 39 % in the firm's debt and 61% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's WACC is the same as the expected return on its assets.

1. If the assets will be worth $1,190 in one year, the expected return on assets will be

_______% (Round to one decimal place.)

2. If the assets will be worth $970 in one year, the expected return on assets will be

_____% (Round to one decimal place.)

3. The expected return on assets will be _______%. (Round to one decimal place.)

4. For a portfolio of 39% debt and 61% equity, the expected return on the debt will be

_________% (Round to one decimal place.)

5. If the equity will be worth $769.60 in one year, the expected return on equity will be

______%(Round to one decimal place.)

6. If the equity will be worth $549.60 in one year, the expected return on equity will be

________% (Round to one decimal place.)

6. The expected return on equity will be ________%

The expected pre-tax return on a portfolio of

39% debt and 61% equity will be _______%.

(Round to one decimal place. There may be a slight difference due to rounding.)

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