Illustrate the effect of leverage on returns

Reference no: EM132208145

Question -

a) XYZ Ltd is currently all equity financed with a market value is $1 million. Its management is considering the issue of bonds with a face value of $500,000 which are expected to be issued at face value. The new funds raised will be used to repurchase shares from existing shareholders. Illustrate the effect of leverage on returns to shareholders by sketching the relationship for the all equity situation and the proposed (50% debt, 50% equity) on a clearly labeled graph. DO NOT USE EXCEL

b) All firms face business risk. What additional risk do shareholders face under the proposed capital structure in part (a)? Illustrate the effects of this risk by rearranging the before-tax weighted average cost of capital equation. Note that the intermediate steps in the rearrangement are not required.

Reference no: EM132208145

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