Susan, a treasurer of the Gammamax Company, has proposed that the company should sell equity and buy back debt in order to maximize its value. As evidence, she presents the financial statements given in Table below.

Income Statement Before After Net Operating Income 100 100 Interest expense 80 40 Earnings Before Tax 20 60 Tax at 50% 10 30 Net Income 10 30 The company currently has a price/earnings ratio of 50. Before the change in capital structure it has 10 shares outstanding; therefore its earnings per share are Kshs.1.00, and the price per share is Kshs.50. If 10 new shares are issued at Kshs. 50 each, Kshs.500 is collected and used to retire Kshs.500 of debt (which pays a coupon rate of 8%). After the capital structure change, earnings per share have increased to Kshs.1.50 (since there are now 20 shares outstanding); and with a price/earnings ratio of 50, presumably the price per share will increase from Kshs.50 before the capital structure change to Kshs.75 afterward. Given your understanding of modern finance theory, discuss the above proposal