"Toy World" (TWD) is considering expanding into new geographic markets. The expansion will have the same business risk as TWD's existing assets. The expansion will require an initial investment of $50 million and is expected to generate perpetual EBIT of $20 million per year. After the initial investment, future capital expenditures are expected to equal depreciation, and no further additions to net working capital are anticipated. TWD's existing capital structure is composed of $500 million in equity and $300 million in debt (market values), with 10 million equity shares outstanding. The unlevered cost of capital is 10%, and TWD's debt is risk free with an interest rate of 4%. The corporate tax rate is 25%, and there are no personal taxes.

a. TWD initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share TWD's view of the expansion's profitability, what will the share price be once the firm announces the expansion plan ($)?

b. Suppose investors think that the EBIT from TWD's expansion will be only $4 million. What will the share price be in this case? ($)?

c. How many shares will the firm need to issue in the case of item (b)?

d. Suppose TWD issues equity as in item (b). Shortly after the issue, new information emerges that convinces investors that management was, in fact, correct regarding the cash flows from the expansion. What will the share price be now?

e. Why does the price in item (d) differ from that found in item (a)?

	A. The share price is now lower than the answer from item (a), because in item (a), share price is fairly valued, while in (d) shares that were issued overvalued in item (b) destroyed value for the shareholders who bought them in (b).
	B. The share price is now lower than the answer from item (a), because in item (a), share price is fairly valued, while in (d) shares that were issued undervalued in item (b) created value for the shareholders who bought them in (b).
	C. The share price is now lower than the answer from item (a), because in item (a), share price is fairly valued, while in (d) shares that were issued undervalued in item (b) destroyed value for the shareholders who bought them in (b).
	D. The share price is now lower than the answer from item (a), because in item (a), share price is fairly valued, while in (d) shares that were issued overvalued in item (b) created value for the shareholders who bought them in (b).

f. Suppose TWD instead finances the expansion with a $50 million issue of permanent risk-free debt. If TWD undertakes the expansion using debt, what is its new share price once the new information comes out ($)? Assume TWD don't issue equity as in items (a) to (e).

g. What are the two advantages of debt financing in the case of item (f)?

Question 10 options:

	A. The tax shield of debt at $1.25 per share and the benefits of agency at $1.13 per share.
	B. The tax shield of debt at $1.25 per share and the avoidance of agency costs at $1.13 per share.
	C. The tax shield of debt at $1.25 per share and the avoidance of asymmetry of information at $1.13 per share.
	D. The tax shield of debt at $1.25 per share and the avoidance of financial distress at $1.13 per share.