Question $5$

I. NRG Energy, Inc. $($NRG$)$ is an energy company with a market debt$-$equity ratio of $2.$ Suppose its current debt cost of capital is $6\%,$ and its equity cost of capital is $12\%.$ Suppose also that if NRG issues equity and uses the proceeds to repay its junior debt and reduce its debt$-$equity ratio to $1,$ it will lower its debt cost of capital to $5\mathrm{.}5\%.$ With perfect capital markets, what effect will this transaction have on NRG$\text{'}$s equity cost of capital and WACC? What would happen if NRG issues even more equity and pays off its debt completely? How would these alternative capital structures affect NRG$\text{'}$s enterprise value? $(8$ marks$)$

II$.$ Apple is considering expanding into a new product line. Earnings per share are expected to be $$5$ in the coming year and are expected to grow annually at $5\%$ without the new product line but growth would increase to $6\%$ if the new product line is introduced. To finance the expansion, Apple would need to cut its dividend payout ratio from $80\%$ to $50\%.$ If Apple's equity cost of capital is $12\%,$ what would be the impact on Apple's stock price if they introduce the new product line? Assume the equity cost of capital will remain unchanged. $(9$ marks$)$

III. What options does a firm have to spend its free cash flow $($after it has satisfied all interest obligations$)?(2$ marks$)$