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An unlevered ( all - equity ) firm has 5 0 0 , 0 0 0 common shares trading at $ 4 0 per share.

 

An unlevered (all-equity) firm has 500,000 common shares trading at $40 per share. With its investment plan fixed, it is expected to generate a perpetual EBIT stream of $3 million per year. The corporate tax rate is 40%. The firm is contemplating taking on debt by issuing a $10 million face value perpetual bond at par, carrying a 5% coupon rate per year, and using the proceeds to retire some of its stock outstanding.

What rate of return do shareholders require before the firm changes its capital structure?

 


 
  
 
What will be the firm value after the firm changes its capital structure?

  


  


  
What will be firm's cost of equity after the firm changes its capital structure?

 


What will be the share price after the firm changes its capital structure?

 
 
Suppose you are holding 100 shares bought at $40 per share just before the firm changes its capital structure. What will be your capital gain tax by selling your 100 shares just after the firm changes its capital structure? Assume that the capital gain will be taxed at 20%.

 

  
What will be the firm's WACC after the firm changes its capital structure?

 


 
Will WACC equal ROEU with no corporate taxes?

  

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