Question
Identify the relevant changes resulting from the following independent scenarios. Focus on capital structure effects only and ignore any other indirect effects on the business.
Identify the relevant changes resulting from the following independent scenarios. Focus on capital structure effects only and ignore any other indirect effects on the business.
a) Firm X takes out a loan to repurchase shares. Assume that all Modigliani and Miller assumptions hold. (2 Marks)
Firm value will: Answerincreasedecreaseremain unchanged
Cost of equity will: Answerincreasedecreaseremain unchanged
Weighted average cost of capital will: Answerincreasedecreaseremain unchanged
The present value of tax shields will: Answerincreasedecreaseremain unchanged
b) Firm Y issues shares to repay debt. Assume the existence of corporate tax, but no information or transaction costs. (2 Marks)
Firm value will: Answerincreasedecreaseremain unchanged
Cost of equity will: Answerincreasedecreaseremain unchanged
Weighted average cost of capital will: Answerincreasedecreaseremain unchanged
The present value of tax shields will: Answerincreasedecreaseremain unchanged
c) The corporate tax rate suddenly increases by a material amount. Assume no information or transaction costs. Consider the resulting capital structure effects only. (2 Marks)
Firm value will: Answerincreasedecreaseremain unchanged
Cost of equity will: Answerincreasedecreaseremain unchanged
Weighted average cost of capital will: Answerincreasedecreaseremain unchanged
The present value of tax shields will: Answerincreasedecreaseremain unchanged
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