Leverage and the Cost of Capital. Hubbard’s Pet Foods is financed 80% by common stock and 20% by bonds. The expected return on the common stock is 12%, and the rate of interest on the bonds is 6%....

Leverage and the Cost of Capital. Hubbard’s Pet Foods is financed 80% by common stock and
20% by bonds. The expected return on the common stock is 12%, and the rate of interest on the
bonds is 6%. Assume that the bonds are default free and that there are no taxes. Now assume
that Hubbard’s issues more debt and uses the proceeds to retire equity. The new financing mix
is 60% equity and 40% debt. If the debt is still default free, what happens to the following?
(LO16-1)
a. The expected rate of return on equity
b. The expected return on the package of common stock and bonds