Yerba Industries is an all$-$equity firm whose stock has a beta of $0\mathrm{.}90$ and an expected retum of

$16\mathrm{.}5\%.$ Suppose it issues new risk$-$free debt with a $6\%$ yield and repurchases $55\%$ of its stock.

Assume perfect capital markets.

a$.$ What is the beta of Yerba stock after this transaction?

b$.$ What is the expected retum of Yerba stock after this transaction?

c$.$ Suppose that prior to this transaction, Yerba expected eamings per share this coming year of

$$5,$ with a forward $\frac{P}{E}$ ratio $($that is$,$ the share price divided by the expected earnings for the

coming year$)$ of $9.$

What is Yerba's expected eamings per share after this transaction? Does this change benefit

shareholders? Explain.

d$.$ What is Yerba's forward $\frac{P}{E}$ ratio after this transaction? Is this change in the $\frac{P}{E}$ ratio

reasonable? Explain.

You are CEO of a high$-$growth technology firm. You plan to raise $$170$ million to fund an expansion

by issuing either new shares or new debt. With the expansion, you expect eamings next year of $$27$

million. The firm currently has $10$ million shares outstanding, with a price of $$74$ per share. Assume

perfect capital markets.

a$.$ If you raise the $$170$ million by selling new shares, what will the forecast for next year's

earnings per share be$?$

b$.$ If you raise the $$170$ million by issuing new debt with an interest rate of $10\%,$ what will the

forecast for next year's earnings per share be$?$

c$.$ What is the firm's forward $\frac{P}{E}$ ratio $($that is$,$ the share price divided by the expected earnings

for the coming year$)$ if it issues equity? What is the firm's forward $\frac{P}{E}$ ratio if it issues debt?

How can you explain the difference?

Zelnor, Inc., is an all$-$equity firm with $80$ million shares outstanding currently trading for $$14\mathrm{.}58$ per

share. Suppose Zelnor decides to grant a total of $8$ million new shares to employees as part of a

new compensation plan. The firm argues that this new compensation plan will motivate employees

and is a better strategy than giving salary bonuses because it will not cost the firm anything.

a$.$ If the new compensation plan has no effect on the value of Zelnor's assets, what will be the

share price of the stock once this plan is implemented?

b$.$ What is the cost of this plan for Zelnor's investors? Why is issuing equity costly in this case?