. A start-up company Amazonian.com is considering expanding into new product markets. The expansion will require an initial investment of $160 million and is expected to generate perpetual EBIT of $40 million per year. After the initial investment, future capital expenditures are expected to equal depreciation, and no further additions to net working capital is anticipated. Amazonian.coms existing capital structure is composed of equity with a market value of $500 million and debt with a market value of $300 million, and has 10 million shares outstanding. The unlevered cost of capital for Amazonian.com is 10%, and Amazonian.coms debt is risk free with an interest of 4%. The expansion into the new product market will have the same business risk as Amazonian.coms existing assets. The corporate tax rate is 35%, there are no personal taxes or costs of financial distress. QUESTION:

a) Amazonian.com initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share Amazonian.coms view regarding expansions profitability, what will the share price be once the firm announces the expansion plan?

b) Suppose investors think that the perpetual EBIT from Amazonian.coms expansion will be only $4 million per year. What will the share price be in this case? How many shares will the firm need to issue to finance the project?

c) Suppose Amazonian.com issues equity as in part (b). Shortly after the issue, new information emerges that convinces investors that management was, in fact, correct regarding the cash flows from the expansion. What will the share price be now? Why does if differ from that found in part (a)?

d) Suppose Amazonian.com instead finances the expansion with an issuance of permanent risk-free debt worth 160m. Continue to assume that investors believe that the expansions EBIT will be 40m a year. If Amazonian.com undertakes the expansion using debt, what is its new share price once new information comes out? Comparing your answer with that in part (c), what are the two advantages of debt financing in this case?