1. Microsoft has an equity value of $250B, but has only $10B in debt. Management decides theyd like to increase the D/(D+E) ratio to 40% and use the proceeds to repurchase shares of equity, i.e. a leveraged recapitalization.

a. Before the recapitalization, the debt is considered risk-free and the equity has a beta of 1.13; afterwards, the debt beta becomes 0.3. How much debt does Microsoft issue? By how much has this restructuring changed the riskiness of equity in Microsoft, i.e. what is the equity beta after the recapitalization?

b. If the risk-free rate is 3% and the expected market return is 9%, what are the expected returns to equity holders before and after the recapitalization?