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Next year, there are two possible values for its assets, each equally likely: $1 190...

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Finance

Next year, there are two possible values for its assets, each equally likely:

$1 190

and

$970.

Its debt will be due with

4.9%

interest. Because all of the cash flows from the assets must go to either the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested

39%

in the firm's debt and

61%

in its equity will have the same expected return as the assets of the firm. That is, show that the firm's pre-tax WACC is the same as the expected return on its assets.

For a portfolio of

39%

debt and

61%

equity, the expected return on the debt will be

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