Question

Ethier Enterprise has an unlevered beta of 1. Ethier is financed with 55% debt and has a levered beta of 1.1. If the risk free rate is 6% and the market risk premium is 4%, how much is the additional premium that Ethier's shareholders require to be compensated for financial risk? Round your answer to two decimal places.

Answer 1

The correct answer is 0.4%.

Step-by-step explanation:

According to the scenario, the computation for the given data are as follows:

If no debt, then required return can be calculated by using following formula:

Required return ( no debt) = Risk free rate + Unlevered Beta × Market risk premium

= 6% + 1 × 4%

= 0.06 + 0.04

= 0.10 or 10%

If debt, then required return can be calculated by using following formula:

Required return ( with debt) = Risk free rate + levered Beta × Market risk premium

= 6% + 1.1 × 4%

= 0.06 + 0.044

= 0.104 or 10.4%

So, extra premium required = 10.4% - 10% = 0.4%