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 $10\mathrm{.}2\%.$ Hubbard

does a leveraged recapitalization, issuing debt and repurchasing stock, until its debt$-$to$-$equity ratio is

$0\mathrm{.}58.$ Due to the increased risk, shareholders now expect a return of $15\mathrm{.}2\%.$ 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 $8\mathrm{.}5\%.$ 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 $4\mathrm{.}25\%$ expected return, and its new debt

is risky with a $5\%$ expected retum. Estimate Mercer's equity cost of capital after the