(a) With thorough and accurate reference to Modigliani and Miller’s two capital structure propositions, critically evaluate the effect of a firm increasing its debt-to-equity ratio on its rEquity, rDebt and rAssets. Include in your discussion the implication of the debt not being risk-free and the presence of taxation. Summarise your discussion in a well-labelled graph. 

(b) GHI plc’s rDebt is 7.35%. Its debt-to-equity ratio is 0.5, and its current levered equity beta is 1.5. The current risk-free rate in the market is 5%, and the expected return on the market proxy is 9%.

(i) What is GHI plc’s rEquity? State which model you have used, and show your working. 

(ii) The market value of GHI plc’s debt is currently £15 million. However, GHI plc plans to issue enough stock to retire half of this debt. Assuming no taxes and that rDebt remains at 7.35%, calculate GHI plc’s new cost of equity after the capital structure changes. Show and annotate your working. State which component of your solution can be considered GHI plc’s WACC. State what WACC stands for and why it is an important measure in Corporate Finance. 

(c) What is a rights issue? Why would management decide to do one, and why might existing shareholders prefer it to a seasoned equity offering?