Health and Wealth Company Is Financed Entirely by Common Stock

question 40

Multiple Choice

Health and Wealth Company is financed entirely by common stock that is priced to offer a 15% expected return.If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%,what is the expected return on the common stock after refinancing? (Ignore taxes.)

• A)18.0%
• B)21.0%
• C)15.0%
• D)10.5%

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Definitions:

Opportunity Cost

The cost of foregone alternatives; the value of the best alternative that is not chosen in order to pursue a certain action.

Implicit Cost

The opportunity cost associated with a firm's use of resources that it owns, which do not have a direct monetary payment but could generate income if deployed elsewhere.

Option

A financial derivative that gives the holder the right, but not the obligation, to buy or sell an asset at a specified price within a given timeframe.

Rate of Inflation

The percentage increase in the general price level of goods and services in an economy over a period of time.