Executive Cheese has issued debt with a market value of $100 million and has outstanding 15 million shares with a market price of $10 a share. It now announces that it intends to issue a further $60 million of debt and to use the proceeds to buy back common stock. Debtholders, seeing the extra risk, mark the value of the existing debt down to $70 million.

a. How is the market price of the stock affected by the announcement?

b. How many shares can the company buy back with the $60 million of new debt that it issues?

c. What is the market value of the firm (equity plus debt) after the change in capital structure?

d. What is the debt ratio after the change in structure?

e. Who (if anyone) gains or losses?