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 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

b) The corporate tax rate suddenly decreases 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

c) Firm Z has a level of debt that is consistent with its target debt-to-equity ratio. Assuming taxes and information and transaction costs exist, what is the effect of an increase in debt? (2 Marks)

Firm value will: Answerincreasedecreaseremain unchanged

Agency Cost will: Answerincreasedecreaseremain unchanged

Weighted average cost of capital will: Answerincreasedecreaseremain unchanged

The present value of tax shields will: Answerincreasedecreaseremain unchanged