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)

Cost of equity will: Answerincreasedecreaseremain unchanged

Weighted average cost of capital will: Answerincreasedecreaseremain unchanged

The present value of tax shields will: Answerincreasedecreaseremain unchanged

Agency costs will: Answerincreasedecreaseremain unchanged

b) 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

Cost of equity will: Answerincreasedecreaseremain unchanged

Weighted average cost of capital will:Answerincreasedecreaseremain unchanged

Agency costs will: Answerincreasedecreaseremain unchanged

c) Senior management has recently placed restrictions on middle managers discretionary use of company cash for their own entertainment. Assume the existence of taxes and information and transaction costs. (2 Marks)

Cost of equity will: Answerincreasedecreaseremain unchanged

Firm value will: Answerincreasedecreaseremain unchanged

The present value of tax shields will: Answerincreasedecreaseremain unchanged

Agency costs will: Answerincreasedecreaseremain unchanged