Exercise 1 (Financial Leverage and Capital Structure Policy)

GRK Co. is currently an all-equity firm with an expected return of 10%. The expected EBIT is $ 50,000 forever. Assume that the firm distributes all the net income to the equity holders. The firm is considering a leveraged recapitalization in which it would borrow $ 250,000 and repurchase existing shares. The firm's tax rate is 40%. The cost of debt is 7%.

1/ Calculate the value of the firm with leverage.

2/ Calculate the expected return of equity after recapitalization.

3/ Calculate the cost of capital of the firm after recapitalization.

Exercise 2 (Dividends and Dividend Policy)

The target capital structure of the IGF Company is 0.25 and the net income is $18.5 million. The company needs a new investment on fixed assets equals $20 million.

Compute the dividends under a residual dividend policy.