1. (14 points) Buffalo National Corp. (BNC) is currently an all-equity firm worth $320 million with 50 million common shares outstanding. BNC plans to announce that it will issue $120 million of perpetual debt (i.e., bonds) in order to buy back shares. BNC currently generates annual pretax earnings (EBT) of $80 million, and this level of earnings is expected to remain constant (i.e., EBIT will be $80 million) in perpetuity after the debt issuance and capital restructuring. The bonds will sell at par with an 8% annual coupon rate. BNCs tax rate is 35%. BNC will maintain the new capital structure indefinitely. There is no financial distress cost, other agency cost, or personal income tax.

1) (a) (1 pts) In the market-value balance sheet of BNC before announcing the debt issuance, what is the market value of equity?

(b) (1 pts) What is the stock price of unlevered BNC? (c) (1 pts) What is the expected return on equity before the announcement of the debt issuance (i.e., the cost of unlevered equity)?

2) (a) (2 pts) In the market-value balance sheet upon the announcement of the debt issuance, what is the market value of equity?

(b) (1 pts) What is the stock price of BNC upon announcement?

3) (a) (2 pts) In the market-value balance sheet after buying back shares, what is the market value of equity?

(b) (1 pts) What is the stock price of BNC after buying back shares?

4) (3 pts) What is the cost of equity capital after the change in its capital structure?

5) (2 pts) What is levered BNCs overall cost of capital?