Assume you are in a Modigliani and Miller world $($M &M propositions I and II hold$).$ AB Corporation is unlevered and is valued at $$640,000.AB$ is currently deciding whether including debt in their capital structure would increase their value. Under consideration is issuing $$300,000$ in new debt with an $8\%$ interest rate. $AB$ would repurchase $$300,000$ of stock with the proceeds of the debt issue. There are currently $32,000$ shares outstanding and their effective marginal tax bracket is zero.

Requirement

$($i$)$ State, using supporting M&M theory, what the firm value will be after the change. $(5$ marks$)$

$($ii$)$ State, with supporting arguments, what the share price will be and how many shares will be outstanding after the change.

$(5$ marks$)$

$($iii$)$ Now assume you are in a Modigliani Miller world with corporate taxes added. CD Corp. is all equity financed with $5,000$ shares outstanding worth $$7$ each. They are planning on issuing $$10,000$ of new perpetual debt at the $8\%$ market rate of interest. The effective tax rate is $25\%.$ What is the market value of the firm's outstanding equity after they make the debt for equity exchange?

$(5$ marks$)$