I have very limited finance knowlegde and want to learn this question and its answer. I want to know where the 0.8 came from in the after calculation and what does the 0.2 in the after calculation represent. how are these values obtained ? what is the formula?

Question :The common stock and debt of ABC are valued at $60 million and $40 million, respectively, Investors currently require a 20% return on the common stock and an 8% return on the debt. If ABC issues an additional $20 million of common stock and uses this money to retire debt, what happens to the market value of ABC and to the expected return of its stock? Assume the change in capital structure does not affect the risk of the debt and that there are no taxes and the MM irrelevance proposition holds. If the risk of the debt did change, would your answer underestimate or overestimate the expected return on the stock? Explain

Answer:

Before: WACC= .6*.2 + .4*.08 = 15.2% After: WACC= .8* r S + .2*.08= 15.2% r S =(15.2%-.2*.08)/.8 = 17% Most likely, when leverage increases, the risk of debt will fall. Therefore, rS is likely to be over- estimated under MM, as shareholder will require a lower return due to lower risk. As a result, the value of the company is under stated assuming there are no change to cash flows.