1.The common stock and debt of Southern Technologies are valued at $50 million and $100 million, respectively.Investors currently require a 15% return on the common stock and a 5% return on the debt.Southern Technologies decides to issue an additional $25 million of common stock and uses this money to retire debt.Assume that the Modigliani-Miller (1958) theory holds so that there are no taxes and the change in the capital structure does not affect financial risk.Calculate the following:

a.The unlevered cost of equity financing.

b.The cost of equity financing after the stock issue.

c.The value of the firm after the stock issue.

d.The WACC of the firm after the stock issue.

2. Air Seattle is looking to change its capital structure from an all-equity firm to a levered firm.The perpetual operating income for Air Seattle is $250,000 and its unlevered cost of equity is 10%.If Air Seattle issues debt, it can do so at a cost of 6%.Assume that the Modigliani-Miller (1963) theory holds so that the corporate tax rate is 40% and the change in the capital structure does not affect financial risk.Calculate the following, assuming Air Seattle issues $500,000 of debt:

a.The value of the firm after the debt issue.

b.The cost of equity financing after the debt issue.

c.The WACC after the debt issue.

3.Trade-off theory suggests that the capital structure decision is essentially a cost-benefit analysis.What benefit and cost do firms compare when making financing decisions?

4.According to pecking order theory, firms will first use internal financing (retained earnings) to finance projects.Why is that the case? Consider four sources of financing: newly issued debt, newly issued hybrid securities (such as preferred stock or convertible bonds), newly issued common shares, and retained earnings.According to the theory, in what order will the sources of financing be used?

5. Assume the corporate tax rate is 30%, the personal tax rate on interest income is 40%, and that a change in capital structure does not affect financial risk. What personal tax rate for equity income would make an investor indifferent to a firm's capital structure decisions?

6. Market evidence suggests that four main factors influence firm's financing decisions.Briefly explain how each of the factors below appear to affect the decision to use debt as a funding source.

a.Profitability

b.Firm size

c.Tangible assets

d.Growth opportunities