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The risk-free rate is 6% and the return on the stock market is 10%. Speedy Auto Parts is considering a merger with Freeman Car Parts. Freeman's market-determined beta is 0.9, the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%. If Speedy acquires Freeman, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%.
a. Calculate the current required return to Freeman's equity
b. Calculate Freeman's unlevered cost of equity
c. What will be Freeman's required rate of return on equity after it is acquired?
Hint: Calculate Freeman's levered cost of equity at the new capital structure with the new cost of debt.
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