Inputs$/$Description Value

Shares Outstanding: $$10,000,000$

Share Price: $$75$

Current Debt Outstanding: $$100,000,000$

Proposed Debt Raise: $$350,000,000$

Target Dividend: $$250,000,000$

Cost of Equity: $8\mathrm{.}50\%$

Cost of Current Risk Free Debt: $4\mathrm{.}25\%$

Cost of Risky Debt: $5\%$

Scenario: Analyst IQ has just announced that it will issue $$350$M worth of debt. It will use the proceeds from this debt to pay off its existing debt od $$100$M and use the remaining $$250$M to fund new projects.

a$)$ Estimate Analyst IQ$$s share price just after the recapitalization is announced but before the transaction occurs.

b$)$ Estimate Analys IQ$$s share price at the conclusion of the transaction. $($Hint: Use the market value balance sheet$)$

c$)$ Suppose Analyst IQ$$s debt was risk free with a $4\mathrm{.}25\%$ expected return, and its new debt is risky with a $5\%$ expected return. Estimate Analyst IQ$$s equity cost of capital after the transaction.

d$)$ What are the three conditions that must be met for capital markets to be considered perfect.

e$)$ According to MM $($Modigiliani & Miller$)$ proposition II$,$ the cost of capital for the levered firm remains unchanged in a perfect capital market. Explain.