Reference no: EM132699099

Question 1: Air Canada is currently 100% equity financed. The CFO is considering a recapitalization plan under which the firm would issue long-term debt with a yield of 13% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets, nor would it affect the firm's basic earning power, which is currently 16%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would occur for sure if the company goes ahead with the recapitalization plan)?

a. The company's net income would increase
b. The company's earnings per share would decline.
c. The company's cost of equity would increase.
d. The company's ROD would decline

Question 2: A mutual fund focused on the financial services sector has 3 different stocks in its portfolio( Royal Bank, BMO and CIBC). Royal Bank, BMO and CIBC'S stock have betas of 0.8,1,0 AND 1.2 respectively. The mutual fund invested one-third of its money equally in each stock. Each stock has standard deviation of 25% and their returns are independent of one another, i.e., the correlation coefficients between each pair of stock is zero. If market is in equilibrium, which of the following is correct?

a. The mutual fund's expected return is greater than the expected return of CIBC.
b. The mutual fund's expected return is equal to the expected return on Royal Bank
c. The mutual fund's expected return is less than the expected return on BMO
d. The mutual fund's expected return is equal to the expected return on BMO