The market value of a company is $32.5 million and its cost of capital is 18% per year. The company proposes to repurchase $5 million of equity and replace it with 13% irredeemable loan stock. The company’s earnings before interest and tax are expected to be constant for the foreseeable future.
A. Using the assumptions of Modigliani and Miller (1958) discuss and demonstrate how this change in the capital structure will affect the value of the company’s:
- Cost of Equity
- Cost of Capital
- Market Value
B. using the assumptions of Modigliani and Miller (1961) discuss how the change in the capital structure will affect the value of the company. Assume a corporate tax of 35%?