Hubbard’s Pet Foods is financed 90% by common stock and 10% by bonds.
The expected return on the common stock is 12.7%, and the rate of
interest on the bonds is 6.9%. Assume that the bonds are default-free
and that there are no taxes. Now assume that Hubbard’s issues more debt
and uses the proceeds to retire equity. The new financing mix is 72%
equity and 28% debt.
Required:
a. If the debt is still default-free, calculate the expected rate of return on equity?
b. Calculate the expected return on the package of common stock and bonds?
