Explanation:
Initial Equity = Assets - Debt = $20m - $10m = $10m.
After borrowing an additional $6.0m:
$10m + $6m = $16m.$20m + $6m = $26m.$10m.$26m / $10m = 2.6.The firm's return on equity (ROE) is calculated as: ROE = ROA + (Debt / Equity) * (ROA - Cost of Debt) ROE = 9.0% + (16 / 10) * (9.0% - 4.0%) = 9.0% + 1.6 * 5.0% = 9.0% + 8.0% = 17.0%.
Therefore, the new leverage is 2.6 and the new ROE is 17.0%.
Ultimate access to all questions.
$20.0 million and debt of $10.0 million. Return on assets (ROA) is 9.0% and cost of debt is 4.0%, such that the firm's leverage is 2.0 and its return on equity (ROE) is 14.0%. If the firm borrows an additional $6.0 million at the same cost of 4.0%, and asset returns are fixed, what is the firm's new leverage and return on equity (ROE)?A
Leverage = 1.7 and ROE = 13.3%
B
Leverage = 2.0 and ROE = 15.7%
C
Leverage = 2.3 and ROE = 23.5%
D
Leverage = 2.6 and ROE = 17.0%
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