1)Assume that firm XYZ has a debt/equity ratio of 1/3. The firm has the following capital structure:

Coupon Rate or

SecurityMarket ValueCost of Capital

Debt$100 million12%

Equity$300 million24%

The 12% cost of capital for Debt is the yield of the debt. Assume further that the firm's unlevered cash flows may be represented as a (constant) perpetuity. Assume that the firm wishes to increase the debt/equity ratio to 1.2 and assume no change in the probability of default. Determine, assuming a corporate tax rate of 34%.

a)Find the new ATWACOC

b)Find the New Cost of Equity

c)Find the new Value of the firm

d)Find the new levels of debt and equity

e)Find the expected price per share, assuming that there are currently 5 million shares outstanding.

2. Assume that the sales of the firm in problem 1 are $100 million before the recapitalization. Hence assume that the level of debt is still $100 million. Fixed operating costs are $20 million and variable costs are 50% of sales.

a)Determine the operating, financial and total degree of leverage.

b)Determine the expected percentage decrease in earnings for a decrease of 25% of sales.