Question #3.

Windsor, Inc. is currently an all-equity financed firm, and its cost of equity is 12%. It has 20,000 shares outstanding that sell for $25 each. The firm contemplates a restructuring that would borrow $100,000 in perpetual debt at an interest rate of 8% which will be used to repurchase stock. Assume that the corporate tax rate is 35%.

(1) Calculate the present value of the interest tax shields and the value of the firm after the proposed restructuring. (8 marks)

(2) What will be shareholders required rate of return after the proposed restructuring? Is it higher or lower than 12%? Why or why not? (12 marks)

Question #4.

State the dividend irrelevance proposition. What are the assumptions behind this proposition? Explain why this proposition does not hold in the real world. (20 marks)