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2 April, 05:34

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.

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  1. 2 April, 05:40
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    The correct answer is 0.4%.

    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%
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