Assume a firm's debt is risk-free, so that the cost of debt equals the risk-free rate, R
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Assume a firm's debt is risk-free, so that the cost of debt equals the risk-free rate, Rf . Define βA as the firm's asset beta-that is, the systematic risk of the firm's assets. Define βE to be the beta of the firm's equity. Use the capital asset pricing model (CAPM) along with M&M Proposition II to show that βE = βA × (1 + D/E ), where D/E is the debt-equity ratio. Assume the tax rate is zero.
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To derive the equation E A 1 DE we can use the Capital Asset Pricing Model CAPM and MM Proposition I...View the full answer
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Related Book For 
Fundamentals of corporate finance
ISBN: 978-0073382395
9th edition
Authors: Stephen Ross, Randolph Westerfield, Bradford Jordan
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