The TQM Corporation is located in a country where there are perfect capital markets and no taxes. The corporation currently has $120 million in equity and $60 million in risk free debt. The return on equity, rS, is 18% and the cost of debt, rB, is 9%. Suppose TQM decides to issue additional equity to repurchase the $60 million in debt so that it will have an all-equity capital structure. 1. If TQM did this, what would the total value of the firm be after the refinancing?

2. What would the return on equity, rS, be after the refinancing?

3. Before the refinancing, a shareholder, Sheila, holds $1 million of TQM stock and $2 million of risk free debt. What is her holding of TQM stock and risk free debt after the refinancing, if she wants to keep the same level of risk in her portfolio?

4. After the refinancing, suppose the firm announces a project costing $5 million with an NPV of $2 million. Investors do not anticipate the project. The project is to be financed entirely by debt. What is the total value of the firm's equity after the debt for the project has been raised?