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Stock issue versus debt and repurchase of stock

3) Global Pistons has common stock with a market value of $200 million and debt with value of $100 million.
Investors expect a 15% return on the stock and a 6% return on the debt. Assume perfect capital markets.

a) Suppose GP issues $100 million of new stock to buy back the debt. What is the expected return of the stock after this transaction?

b) Suppose instead GP issues $50 million of new debt to repurchase stock.
****if the risk of the debt doesn't change what is the expected return of the stock after this transaction?

5) Your fim currently has $100 million in debt outstanding with a 10% interest rate. The terms of the loan require the firm to repay $25 million of the balance each year.

Suppose that the marginal corp tax rate is 40% and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt?

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ANSWERS
Please see attached file for answers.

Question 3
Based on Modigliani and Miller, the value of the firm is independent of its capital structure, hence the weighted cost of capital under any ...

Solution Summary

The stock issues versus debt and repurchase of stocks are examined.

$2.19