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A firm is currently financed with risk-free debt with a value of $100 million and 5 million shares with a price of $60/share. The costs of debt and equity are 2% and 6%, respectively. (Ignore taxes, financial distress and agency costs, i.e., assume perfect markets. Hint: What does this mean about the effect of capital structure on firm value or WACC?)
Problem a. What are the value of the equity and total firm value?
Problem b. What is the firm's WACC?
Problem c. Assume the firm issues an additional $50 million of risk-free debt and uses the proceeds to buy back equity. (Note that the cost of debt does not change.) After this recapitalization:
i. What will be the value of the debt, the firm, and the equity? ii. What will be the WACC? iii. What will be the cost of equity? iv. Finally what will be the share price and t he number of shares outstanding (in millions)?
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