The Boxer Companys cash flows are either $100 or $200 per year forever. The cash flow is $100 if a hurricane hits Florida next year and $200 otherwise. Both scenarios are equally likely. All uncertainty is resolved one year from now when the first cash flow is received. If there is a hurricane, other firms in the economy will also be affected. Hence the Boxer Company has a nonzero asset beta (its unlevered asset beta is 0.4). The company has no debt and the risk free interest rate is 10%. The market risk premium is 8%. Assume capital markets are perfect and complete.

a) What is the market value of the Boxer Company? What is the wealth of its shareholders? What is the cost of equity?

Now suppose the Boxer Company issues perpetual debt with an annual coupon payment of $150 and pays out the proceeds to shareholders as a special dividend. The beta of debt in this case is 0.2.

b) What is the market value of the Boxer Company now? What is the market value of the newly issued debt and what is the total wealth of shareholders? What is the cost of equity after the transaction?

c) Do the MM propositions hold in this case? Clearly state the MM Propositions 1 and 2 and check whether they hold.