Hello,

I am struggling with some of these financial questions (#3,4 and 6). I would appreciate step by step help and solutions in order for me to understand.

Thank you

Finance 414 - Problem Set #2 - Fall 2017 Due at the start of class on Wednesday, September 20st Chapter 16 Problems #1. Do you agree with the following statement? Explain your answer. "In a world with no taxes or financial distress costs, if a firm issues equity to pay off some of its debt, the price of the shares will increase because the shares become less risky." #2. Spartan Corp. and Wolverine Corp. are identical in all respects except capital structure. Spartan's bonds have a market value of $400 million while Wolverine's bonds have a market value of $200 million. These firms operate in a perfect world where markets are perfectly efficient and there are no taxes or financial distress/bankruptcy costs. Both firms have 10 million shares outstanding. If the stock price for Spartan is $80, what do you predict for the stock price of Wolverine? [Hint: Use Modigliani and Miller] #3. Consider two firms A and B that are identical in all respects except capital structure. Firm A has $160 million in equity outstanding and $40 million in bonds outstanding. Firm B has $200 million in equity outstanding and $0 million in bonds outstanding. (a) Suppose an investor has a $4 million investment in the stock of firm A. What alternative $4 million investment that includes firm B's stock will give the investor the same cash flow payoff in future years as his current investment in firm A's stock? (Hint: I am looking for the amount of cash you would invest in firm B's stock and the amount of cash you would either invest in other securities or borrow from other sources so that $4 million comes out of your pocket today and you get the exact same cash payoff down the road as the current $4 million investment in firm A's stock. See the Modigliani and Miller proof.) (b) Suppose an investor has an $8 million investment in the stock of firm B. What alternative $8 million investment that includes firm A's stock will give the investor the same cash flow payoff in future years as his current investment in firm B's stock? (Hint: I am looking for the amount of cash you would invest in firm A's stock and the amount of cash you would either invest in other securities or borrow from other sources so that $8 million comes out of your pocket today and you get the exact same cash payoff down the road as the current $8 million investment in firm B's stock. See the Modigliani and Miller proof.) #4. Buckeye Corp. is currently an all-equity firm with a market value of equity of $100 million. The current expected return on Buckeye's equity is 25%. Buckeye operates in a world with no taxes. Buckeye is planning on issuing $10 million in debt with an interest rate of 10% and using the cash to repurchase $10 million in shares. (a) After Buckeye repurchases the stock, what will be the expected return on the firm's stock? (b) After Buckeye repurchases the stock, what will be the firm's weighted average cost of capital? #5. A firm currently has no debt. The firm has 10 million shares outstanding and those shares currently have a market price of $30 per share. The firm is contemplating selling $50 million in bonds and using the proceeds to repurchase shares of stock. If they undertake this action, the firm intends to keep this level of debt financing for the foreseeable future. Assume that there are no taxes. Given this data, if the firm announces that they will sell the bonds and repurchase equity what: (a) do you expect the stock price to be immediately after the announcement? (b) will be the firm's total market value of equity immediately after the announcement? (c) do you expect the stock price to be after the bond issue/repurchase are completed? (d) will be the firm's total market value of equity after the bond issue/repurchase are completed? #6. Firms X and Y are identical in all respects except for capital structure. These firms operate in a perfect-world tax-exempt haven where firms and individuals pay no taxes at all. Current data on the financial structure of the two firms is as follows: Firm X: 1,000 shares outstanding, current market price of $10 per share 100 bonds outstanding with a current bond price of $100 per bond Firm Y: 2,000 shares outstanding, current market price of $9 per share 50 bonds outstanding with a current bond price of $100 per bond The bonds in both firms are risk free and the risk-free interest rate is 10%. An individual investor can also borrow or lend from a bank at the 10% risk-free rate. Identify a portfolio that includes a long position in exactly 100 shares of stock in firm X and is guaranteed to make you a risk-free immediate profit. How large are these profits? [Hint: consider the value of unlevered versions of firm X and firm Y and identify a percent of the unlevered versions of these firms in which you go long one and short the other in the same percentages so as to generate a sure profit.]