Problem $16-14$ Leverage and the Cost of Capital $($LO$1)$

A firm currently has a debt$-$equity ratio of $\frac{1}{4}.$ The debt, which is virtually riskless, pays an interest rate of $6\mathrm{.}3\%.$ The expected rate of

return on the equity is $13\%.$ What would be the expected rate of return on equity if the firm reduced its debt$-$equity ratio to $\frac{1}{5}?$

Assume the firm pays no taxes.

Hint: First find the Return on Assets $($WACC assuming no debt$)$ which is expected to stay constant when the debt is risk$-$free $($not

realistic$)$ and when there is no tax benefit of interest expense. Once you solve for the ROA, then find the new ROE. If debt is added,

the ROE should increase $($or decrease if debt is reduced$).$

Note: Do not round intermediate calculations. Enter your answer as a percent rounded to $2$ decimal places.

Expected rate of return on equity