"We R Toys" (WRT) is considering expanding into new geographic markets. The expansion

will have the same business risk as WRT'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

WRT'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 WRT's debt is risk free with an interest rate of 4%. The corporate tax rate is 35%,

and there are no personal taxes.

b. Suppose investors think that the EBIT from WRT'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?

answer; 4*0.65/0.1-50= -24

share price = 500-24/10= 47.6

new share= 50/47.6= 1.05 per share

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)?

share price = (500+50+80)/11.05 = 57

d. Suppose WRT instead finances the expansion with a $50 million issue of permanent riskfree

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?

tax shield = 35%(50)= 17.5

(500+50+80+17.5-50)/10=59.75

please explain those answers especially question b and c