5. Firm A pays 15 million in the good state and 10 million in the bad state. It is an all equity firm and you own 10 per cent of the equity. Assume there are no taxes. The price per share is 10 with one million shares outstanding.

a. What is your payout in the good state and in the bad state?

b. The other owners have decided to recapitalize the firm. They raise 6 million by selling riskless bonds with a face value 7 million. They use this money to repurchase equity at the market price. You did not sell any of your shares. How much equity did they repurchase? What share of equity do you now on? What is your payout in the good state and in the bad state?

c. Compare the expected return on your investment before and after the transaction. Why did the expected return change?

d. You are risk averse and do not like the change to your return profile. Describe what you can do to get your payoff to be just the same as before the transaction. Comment on what the Modigliani Miller 1st proposition in relation to this question.