Question
Consider a world of perfect capital markets and M&M's no tax theory of capital structure is true. Company Y is financed has the following market
Consider a world of perfect capital markets and M&M's no tax theory of capital structure is true. Company Y is financed has the following market value balance sheet: Assets = $900.00 Liabilities = $0 Equity = $900.00 The firm had $63.00 in EBIT last year, and has just paid its annual dividend. The firm has 50 shares outstanding. The firm expects these same returns for the foreseeable future. The firm is a zero growth firm that pays out all excess earnings as a once per year end of year dividend. Any time the firm changes its capital structure; it changes only the debt/equity mix and does not change its total physical assets. The firm's liabilities consist entirely of perpetual debt with annual interest payments. If the firm has debt, the firm's debt is risk-less, selling at par, and has a 2% current yield. If the firm were to change its capital structure, new debt would still have a 2% yield. The market risk premium is 6%.
a. What is the firm's Return on Equity/Cost of Stock?
b. What is the firm's WACC?
Now assume that the above firm issues $450.00 in debt and uses the funds to redeem equity. This change in capital structure reveals no new information about future firm prospects.
c. Write out the firm's New Balance Sheet?
d. What is the firm's new Weighted Average Cost of Capital?
e. What is the firm's new stock price?
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