Chapter 17, Problem 15PS

MM proposition 2 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%. Assuming that the bonds are default-risk-free, draw a graph that shows the expected return of Hubbard’s common stock (r_E) and the expected return on the package of common stock and bonds (r_A) for different debt–equity ratios.