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QUESTION

Calculate the rate of return available to shareholders for a company financing $1 million of assets with the following three arrangements: all equity...

Calculate the rate of return available to shareholders for a company financing $1 million of assets with the following three arrangements:

i. all equity

ii. 50 percent equity and 50 percent debt at an interest rate of 12 percent per annum

iii. 25 percent equity and 75 percent debt at an interest rate of 12 percent per annum

The assets are expected to generate earnings before interest of $150,000 per annum in perpetuity. Interpret your answer and explain what effect a change in the perpetual earnings stream might have on the rate of return available to shareholders.

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