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: Answer increase/decrease/remain unchanged

Cost of equity will: Answer increase/decrease/remain unchanged

Weighted average cost of capital will: Answer increase/decrease/remain unchanged

The present value of tax shields will: Answer increase/decrease/remain 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: Answer increase/decrease/remain unchanged

Cost of equity will: Answer increase/decrease/remain unchanged

Weighted average cost of capital will: Answer increase/decrease/remain unchanged

The present value of tax shields will: Answer increase/decrease/remain 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: Answer increase/decrease/remain unchanged

Cost of equity will: Answer increasedecreaseremain unchanged

Weighted average cost of capital will: Answer increasedecreaseremain unchanged

The present value of tax shields will: Answer increasedecreaseremain unchanged