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Company XYZ has common stock with a market value of $400 million and debt with a value of $200 million. Investors expect a 12% return
Company XYZ has common stock with a market value of $400 million and debt with a value of $200 million. Investors expect a 12% return on the stock and a 4% return on the debt. Assume perfect capital markets and no taxes. Suppose that XYZ decides to issue $ 100 million of new debt to repurchase stock. a) If the risk of the debt does not change, what is the expected return of the stock after this transaction? Discuss your finding. [5 marks] b) If the risk of the debt increases, would the expected return of the stock be higher or lower than in part a? Explain and discuss your result. [5 marks]
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