Alpha Inc. produces umbrellas. Alpha reported an EBIT of $2,000 in their most recent income statement and it is expected that EBIT will not grow for the foreseeable future, given its retention ratio of 0. The firm faces a tax rate of 35% and its investors require a return of 10%. Alphas management has decided to do a debt-for-equity swap, in which the firm will issue $2,000 of perpetual debt in exchange for $2,000 worth of equity in essence, the shareholders will trade some of their equity for debt. The debt carries a coupon rate of 8.5% and will trade at par. Also, assume that there are 1,000 shares outstanding.

What are Alphas cash flows before and after the recapitalization?

calculate Alphas pre- and post-debt value?

why worry about all of this if, in the real world, we are going to estimate cash flows and discount by the WACC?

Calculate Alphas WACC. Note that ra = re for an all-equity firm.

Calculate Alphas post debt value using the WACC.