Question: (a) A firm with a return on common equity (ROCE) of 25% has financial leverage of 35 % and a net after-tax borrowing cost of

(a) A firm with a return on common equity (ROCE) of 25% has financial leverage of 35 % and a net after-tax borrowing cost of 5% on $220 million of net debt. What rate of return does this firm earn on its operations (RNOA)? (b) The firm is considering repurchasing $170 million of its stock and financing the repurchase with further borrowing at a 5% after-tax borrowing cost. What effect will this transaction have on the firms return on common equity if the same level of operating profitability is maintained? (c )Will the normal P/E ratio for this firm change because of this transaction? Why? (d )What explanation would you give for the drop in stock price on an earnings increase? (4 marks) (e ) What is the default premium? (3 marks) (f ) Why are growth stocks often seen as high risk?

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