We R$$ Toys" $($WRT$)$ is considering expanding into new geographic markets. The expansion will have the same business risk as$$ WRT$\text{'}$s existing assets. The expansion will require an initial investment of $ $40$ 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.

$$WRT$\text{'}$s existing capital structure is composed of $ $450$ million in equity and $ $200$ million in debt$($market values$),$ with $10$ million equity shares outstanding. The unlevered cost of capital is $11\%,$ and$$ WRT$\text{'}$s debt is risk free with an interest rate of $5\%.$ The corporate tax rate is $21\%,$ and there are no personal taxes.

a$.$ WRT initially proposes to fund the expansion by issuing equity. If investors were not expecting this$$ expansion, and if they share$$ WRT$\text{'}$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$$ WRT$\text{'}$s expansion will be only$$ $$4$ million. What will the share price be in this$$ case? How many shares will the firm need to$$ issue?

c$.$ Suppose WRT issues equity as in part $($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? Why does it differ from that found in part $($a$)?$

d$.$ Suppose WRT instead finances the expansion with a $ $40$ million issue of permanent$$ risk$-$free debt. If WRT undertakes the expansion using$$ debt, what is its new share price once the new information comes$$ out? Comparing your answer with that in part $($c$),$ what are the two advantages of debt financing in this$$ case?