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Acme Co operates under the assumptions of Modigliani and Miller. Acme's expected earnings (before interest) is $5,000,000, all of which are paid out as dividends.
Acme Co operates under the assumptions of Modigliani and Miller. Acme's expected earnings (before interest) is $5,000,000, all of which are paid out as dividends. The value of Acme's assets is $50,000,000. Acme has no debt and has 10,000,000 shares outstanding that are trading for $5 per share. a (a) A bank offers a proposal to Acme, where Acme would take a loan of $35,000,000 at an annual interest rate of 4% from the bank, which would be used to repurchase its shares. What will be the change in Acmes rate of return on equity under this bank's proposal? (Show all your work. Your answer must be handwritten.) (5 marks) (b) Mary owns 30 shares in Acme and argues that it is unnecessary for Acme to borrow from the bank since she can also borrow from the bank under the same conditions. If Mary borrows money from the bank to buy additional shares of Acme so that Mary's investment outcome is identical to the bank's proposal, how much interest will Mary need to pay the bank? (Show all your work. Your answer must be handwritten.)
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