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XYZ, Inc
XYZ, Inc. has an unlevered beta of 1.0. They are financed with 50% debt and has a levered beta of 1.6. If the risk-free rate is 5.5% and the market risk premium is 6%, how much is the additional premium that XYZ, Inc. shareholders require to be compensated for financial risk?
Expert Solution
Computation of the additional premium:-
Required return with unlevered beta = Risk free rate + (Beta * Market risk premium)
= 5.5% + (1.0 * 6%)
= 5.5% + 6%
= 11.5%
Required return with levered beta = Risk free rate + Beta x market risk premium
= 5.5% + (1.6 * 6%)
= 5.5% + 9.6%
= 15.1%
Additional premium = Required return with levered beta - Required return with unlevered beta
= 15.1% - 11.5%
= 3.6%
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