Assume markets are “perfect” and in equilibrium as described in Chapter 17. Using the following values and the CAPM equation, what is E(rA ), i.e., the expected return for the following firm’s assets?

Notes & perfect market equations:

In equilibrium, required returns (based on risk) = expected returns

CAPM equation: E(rA) = rf + ßA (E(rM) – rf)

WACC = D/V E(rD) + E/V E(rE)

E(rE) = E(rA) + (E(rA) – E(rD))

D/E (MM Proposition 2 equation)

ßA = D/V ßD + E/V ßE

ßE = ßA + (ßA – ßD) D/E

rE = E(rE) =

ßE = 1.5

rf = 2%

rD = E(rD) = 7%

ßD =

rM = E(rM) = 15%

**rA = E(rA ) = Solve for this**

ßA = D/V = 0.6