1. Assuming perfect capital markets:

Firm Xi has a market beta for their equity of 1.2 and currently has a D/E ratio of 1.4. If you consider changing the D/E ratio to 1.6 how does this change the firm’s equity beta (assume the beta of the debt is 0 when the D/E ratio is 1.4, but becomes 0.01 when the D/E ratio is 1.6)? Also figure out the new expected return of the equity if rm=.12 and rf=.04?

2. Flint Co. has FCF of 5 million per year which should grow 5% per year, the expected return on equity is 12% and rD=.06 and the firm has a D/E ratio of 0.7 with an appropriate tax rate of 37%. With the above information, value what the company is worth without an interest tax shield. Now, value the company with a tax shield and explain how much value the interest tax shield adds.