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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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