The SI Corporation operates in an economy with no taxes and perfect capital markets so there are no costs of bankruptcy or any other kind of friction. It has an expected operating income of $100 million per year. The expected amount paid to debt holders is $40 million per year and the expected amount paid to equity-holders is $60 million per year. The debt of the firm is a perpetuity. The expected rate of return on the firm's asset is 12%. The CAPM holds. The rate of return on the market portfolio is 16% and the risk free rate is 6%. The firm's debt currently has a beta of 0.4. The firm has decided to change its debt/equity ratio by issuing equity and using the funds to repurchase debt. After this change in capital structure the remaining debt will be risk free and have a beta of 0 and the expected amount going to debt will be $20 million per year.

1. Before the change in capital structure what is the total value of the firm's debt and equity?

2. After the change in capital structure what is the total value of the firm's debt and equity?

3. What is the expected return on the equity of the firm after it changes its capital structure?

4. Consider a shareholder who initially has an optimal portfolio with total value $10,000 consisting of the equity and debt of the firm in the same proportions as the firm has equity and debt. What will be the optimal value of her holdings of equity and debt of the firm after the firm changes its capital structure (provide both the percentage and dollar value)?