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Global Pistons ( GP ) has common stock with a market value of $ 2 0 0 million and debt with a value of $

Global Pistons (GP) has common stock with a market value of $200 million and debt with a value of
$100 million. Investors expect a.15% retum on the stock and a 6% return on the debt. Assume
perfect capital markets.
a. Suppose GP issues $100 million of new stock to buy back the debt. What is the expected
return of the stock after this transaction?
b. Suppose instead GP issues $50 million of new debt to repurchase stock.
i. If the risk of the debt does not change, what is the expected return of the stock after this
transaction?
ii. If the risk of the debt increases, would the expected return of the stock be higher or
lower than in part (i)?
Hubbard Industries is an all-equity firm whose shares have an expected retum of 10.2%. Hubbard
does a leveraged recapitalization, issuing debt and repurchasing stock, until its debt-to-equity ratio is
0.58. Due to the increased risk, shareholders now expect a return of 15.2%. Assuming there are
no taxes and Hubbard's debt is risk free, what is the interest rate on the debt?
Hartford Mining has 50 million shares that are currently trading for $4 per share and $200 million
worth of debt. The debt is risk free and has an interest rate of 5%, and the expected retum of
Hartford stock is 11%. Suppose a mining strike causes the price of Hartford stock to fall 25% to $3
per share. The value of the risk-free debt is unchanged. Assuming there are no taxes and the risk
(unlevered beta) of Hartford's assets is unchanged, what happens to Hartford's equity cost of
capital?
Mercer Corp. has 10 million shares outstanding and $100 million worth of debt outstanding. Its
current share price is $75. Mercer's equity cost of capital is 8.5%. Mercer has just announced that
it will issue $350 million worth of debt. It will use the proceeds from this debt to pay off its existing
debt, and use the remaining $250 million to pay an immediate dividend. Assume perfect capital
markets.
a. Estimate Mercer's share price just after the recapitalization is announced, but before the
transaction occurs.
b. Estimate Mercer's share price at the conclusion of the transaction. (Hint: Use the market value
balance sheet.)
c. Suppose Mercer's existing debt was risk-free with a 4.25% expected return, and its new debt
is risky with a 5% expected retum. Estimate Mercer's equity cost of capital after the
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