How about the expected return to equity owners and rE

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A firm requires $L to pay for a single project that it wants to invest in. It raises $'a'L by issuing bonds and the remainder by issuing shares. The total payoff of the project if it succeeds is $SL (where S > 1) and the payoff if it fails is $FL (F < 1). The rate of interest is r. How does the expected return to bondholders, rB, vary with 'a', and why? How about the expected return to equity owners, rE,? How does the risk of their respective returns vary with 'a'?

Reference no: EM131835552

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