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Jackson is an all-equity financed firm; its common stock has an expected return of 12%. Jackson...

Question:

Jackson is an all-equity financed firm; its common stock has an expected return of 12%. Jackson plans to issue debt, and use

Jackson is an all-equity financed firm; its common stock has an expected return of 12%. Jackson plans to issue debt, and use the proceeds to repurchase outstanding shares of common stock. If Jackson issues debt such that its debt-equity ratio becomes .60, the new expected return on equity will be 18%. What will be the market yield of the company's debt? Assume perfect markets.

Answers

Levered cost of equity = Unlevered cost of equity+D/E*( Unlevered cost of equity-cost of debt)*(1-tax rate)
18 = 12+0.6*(12-Cost of debt)*(1-0)
Cost of debt% = 2
.

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