Sam Adams Brewery Inc. currently has USD 200m 20in market value of common stock outstanding priced at $20 per share. Sam Adams also has USD 50m in 20 year bonds carrying a 10% coupon. The firm is considering a capital restructuring proposal that consists in issuing new debt for USD 50m and repurchasing an equivalent amount of stock. The interest on the new debt will also be 10%. Earnings before interest and taxes (EBIT) for the firm is USD 35m.

1. (a) If there are no taxes, what will be the effect of the proposed restructuring on earnings per share (EPS), required return on equity and the value of the firms stock?

2. (b) If the firm now pays 34% in taxes, is this restructuring advantageous to Sam Adams Brewery? Support your position quantitatively.

3. (c) The Modigliani and Miller proposition under corporate taxes finds the optimal debt ratio to be very close to 100%. In their world, debt-for-equity restructurings (raise debt to retire equity) is always advantageous. From your perspective, do you believe that this is always true? Identify the tradeoffs a firm must make in determining whether or not to engage in this type of restructuring.