Mercer Corp. has

10

million shares outstanding and

$100

million worth of debt outstanding. Its current share price is

$75.

Mercer's equity cost of capital is

8.5%.

Mercer has just announced that it will issue

$350

million worth of debt. It will use the proceeds from this debt to pay off its existing debt, and use the remaining

$250

million to pay an immediate dividend. Assume perfect capital markets.

a. Estimate Mercer's share price just after the recapitalization is announced, but before the transaction occurs.

b. Estimate Mercer's share price at the conclusion of the transaction.

(Hint:

Use the market value balance sheet.)

c. Suppose Mercer's existing debt was risk-free with a

4.25%

expected return, and its new debt is risky with a

5.00%expected

return. Estimate Mercer's equity cost of capital after the transaction.