CAPITAL STRUCTURE

Firm A is financed with equity of $400 million (market value) and perpetual debt of $1,000 million (market value). The firm wants to reach the optimal target debt-equity ratio of 0.6. Firm A plans to issue equity and repay some of the existing debt. Assume that there is a tax rate of 30%, the markets are efficient, and there are no transaction or bankruptcy costs. Show allyour steps for the questions below.

a) Calculate the amount of debt that Firm A needs to repay to reach the target debt-equity ratio, and the value of debt and equity after the restructuring.

b) Assume that there are 20 million shares outstanding before the restructuring. Calculate the number of shares Firm A must issue to repay the debt needed to reach the target debt-equity ratio.

c) Re-calculate the values for part a) assuming that Firm A's debt is not perpetual, but instead consists of 10-year bonds with a 10% annual coupon rate and a nominal value of $1,000 million. Assume the debt market value is still $1,000 million.

d) Now assume that Firm A operates in a tax-free regime. Re-calculate the values for part a).

e) Now assume that Firm A operates in a tax-free regime. Re-calculate the values for part c).