Indigo Inc. is an all equity financed company, which is valued at E250 million. The firm's shares are expected to produce a return of 15%. The company has decided to modify its capital structure to obtain the tax benefits associated with debt. The company plans to have a target debt/equity ratio of 25 per cent. The management of Indigo Inc. has been informed that any borrowings made by the company will attract a rate of 7 per cent.

a. Calculate the return on equity of Indigo Inc. before and after the restructuring. (15 marks)

b Write a brief report to the management of Sapphire explaining why the return on equity has changed as a result of restructuring.

c Assume that the corporate tax rate is 35 per cent, capital gains tax is zero and the personal income tax rate is 45 per cent. Calculate the value of Indigo Inc.

i) Before the restructuring?

ii) What is its value after?

d.) Compare and contrast the strengths and weaknesses of the adjusted present value, Weighted Average Cost of Capital, and Flow to Equity approaches to investment appraisal. Which method, in your opinion, is the best? Explain. (15 marks) Total: 50 marks