Recall that with no taxes the expected return on assets equals the WACC.

Expected return on equity

= expected return on assets + [debt-equity ratio

´(expected return onassets – expected return on debt)]

= .12 + [.625

´(.12 – .09)]

= .12 + .0188

= 13.88%

The expected return on equity could be reduced by replacing the debt in the capital structure withequity. If debt were eliminated, the expected return on equity would reach its minimum of 12%.