Heavy Duty, a manufacturer of hydraulic tipper trailers for the mining business and its competitor Bull master are located in Folfanga. Folfanga does not charge corporate taxes. In the local stock market, Heavy Dutys shares trade at 40.00 and 2.5 million shares are outstanding. Heavy Dutys next (annual) dividend payment will amount to 10 million and its growth rate (g) is expected to be 3% (the last dividend has just been paid). The companys WACC is 11.00% and the firm is financed by 20% debt in terms of market value (perpetuity assumed).

1. Assume that the EPS will be 8 and that Heavy Duty is able to invest the retained (i.e., plowed back) earnings at its book ROE. What is the firms book ROE?

2. Heavy Dutys competitor Bullmaster is unlevered and has 2.5 million shares outstanding but is otherwise identical to Heavy Duty. Assuming that Miller & Modiglianis propositions hold, what is the fair price of Bullmasters stock?

3. To gain a competitive advantage over Bullmaster, Heavy Dutys executives decide to raise additional debt to fund future investment opportunities. What is the return that bondholders demand, assuming that the firm's (business) risk is not affected by the increase in leverage?

4. Due to a recession, Folfanga has decided to levy corporate taxes. Regarding the corresponding changes in market value of the two competitors, who will suffer more from this decision? Provide a rationale for your response.