What is the expected return on equity

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Case: Suppose that the only market imperfection comes from the presence of corporate taxes, and that the corporate tax rate is 25%. Currently, The Wendy's Company has beta of equity of 0.6 and a debt-to-value ratio of 45%. Wendy's current credit rating is B, which corresponds to a debt beta of 0.25. The CFO plans to reduce Wendy's debt-to-value ratio to 20%, which should improve its credit rating. The CFO expects that after the leverage reduction, its credit rating will be BBB, which corresponds to a debt beta of 0.1. If the risk free rate is 5%, and the market risk premium is 8%, what is the expected return on equity before and after the change in leverage?

Reference no: EM133326446

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