Shop Inc. exhibits an expected operating income of 190,000 in forever, the market value of total assets
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Question:
Shop Inc. exhibits an expected operating income of €190,000 in forever, the market value of total assets is €3 million, and it is financed 40% by debt and 60% by equity. Assume that Shop operates in perfect markets, there are no corporate or personal taxes and both M&M propositions holds. The risk-free rate is 1.5%, the market risk premium is 5%
a) What is the return on assets of Shop?
b) If Shop decides to issue €800,000 of debt and retire an equal amount of equity, what will the rate of return for equity be? The beta of the firm’s debt after the capital structure change is 1/4.
c) Without further information, can you compute the rate of return for equity before the capital structure change?
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