a. The market capitalization of a firm with 100 percent stock equity is $10,000,000. Assume $8,000,000 of .10 debt is substituted for stock (the debt is given to the shareholders). The tax rate is .35.

There are no costs of financial distress. What is the value of the firm after the debt is issued? What is the value of the stock?

b. If the stockholders had no other assets, how much wealth would they have after the debt is issued?

c. If the interest rate on the debt was .05 rather than .10, how do your answers to questions 2b. and 3a. change?

d. If the firm's weighted average cost of capital were .15 with zero debt, what would it be with $8,000,000 of .10 debt?

e. How low can one reduce the WACC by changing the capital structure?