A corporation is evaluating its current capital structure, and considering 2 alternative capital structures.

The company has $2.5 billion debt (face value) outstanding currently rated AA and is selling at a yield of 12% (the market value is 80% of face value). Debt has never to be repaid.

The firm has 50 million shares outstanding which are trading at $80 per share. The firm currently has a price earnings ratio of 10.

The stock has currently a beta of 1.3. The treasury bond rate is 8 percent. The equity risk premium to be applied is 5.5%. The tax rate is 40 percent.

The firm considers the following alternative capital structures:

Alternative 1: issue $1 billion in new stock and repurchase half of the outstanding debt make it an AAA-rated firm, with AAA debt yielding 11% in the market.

Alternative 2: issue $1 billion in new debt to buy back stock. This will drop its rating to A-, with A- debt yielding 13% in the market place. 1. What is the corporation's current market debt/equity ratio? 2. What is the current after-tax cost of debt? 3. What is the current cost of equity? 4. What is the current cost of capital? 5. What is the unlevered cost of capital? 6. What would be the market value of the firm (debt and equity) in $billion in alternative 1? 7. What would be the cost of capital in alternative 1? 8. What would be the market value of the firm's equity after recapitalization in $billion in alternative 2? 9. What would be the best capital structure for the firm? 10. What would be the cost of capital in alternative 2?