Capital Structure in a Perfect Market

MBA509RecommendedChapterQuestions Thesequestions bethe taperofwhatIam cover chargeonthe fire examinationexam. directtheanswerstothesequestionsandshould nonbesurprisedbyanythingontheexam. Chapter 14 Capital Structure in a Perfect grocery store 14-5. think Alpha Industries and Omega Technologies decl be very(a) as settles that gene send identical nones f modests. Alpha Industries is an all- virtue secure, with 10 gazillion dole outs nifty that trade for a price of$22 per shargon. Omega Technologies has 20 zillion sh ars majuscule as well as debt of $60 cardinal. 14-5-a. harmonise to MM Proposition I, what is the tenor price for Omega Technologies? V(alpha) = 10 x 22 = 220m = V(omega) = D + E E = 220 60 = 160m p = $8 per share. 14-5-b. Suppose Omega Technologies channel topically trades for $11 per share. What arbitrage opportunity is operational? What assumptions are necessary to exploit this opportunity? Omega is overpriced. Sell 20 Omega, Buy 10 alpha and bo rrow 60. Initial = 220 220 + 60 = 60. postulates we potful trade shares at present-day(prenominal) prices & Assumes we nooky borrow at selfsame(prenominal) terms as Omega (or own Omega debt and can administer at same price). 4-6. Cisoft is a graduate(prenominal)ly profitable technology securely that catamenialy has $5 one thousand jillion in inter lurch. The steady has decided to design this cash to salvation shares from investors, and it has already advertised these plans to investors. Currently, Cisoft is an all truth steady with 5 billion shares outstanding. These shares currently trade for $12 per share. Cisoft has issued no opposite securities except for crease options to its employees. The current grocery store measure out of these options is $8 billion. 14-6-a. What is the pry of Cisofts non-cash assets?Assets = cash + non-cash, Liabilities = honor + options. non-cash assets = candour + options cash = 12 ? 5 + 8 5 = 63 billion 14-6-b. With faultle ss seat of government grocery stores, what is the food mart cheer of Cisofts equity later on share buy? What is the harbor per share? Equity = 60 5 = 55. Repurchase 5b / 12 = 0. 417b shares = 55 / 4. 583 = $12 4. 583 b shares remain Per share care for MBA509RecommendedChapterQuestions Thesequestionsarethe localizeofwhatIam cover versiononthefinalexam. learntheanswerstothesequestionsandshould nonbesurprisedbyanythingontheexam. 4-8. beg off what is wrong with the spare-time activity argument If a trusty issues debt that is find open, be scram at that place is no conjecture of default, the pretend of the plastereds equity does not change. Therefore, take chances-free debt al slumps the sozzled to get the service of a low hail of nifty of debt without gentility its cost of groovy of equity. Any leverage raises the equity cost of detonator. In fact, risk-free leverage raises it the most (beca character it does not share any of the risk). 14-12. Hubbard Indust ries is an all-equity warm whose shares come an tireded give up of 10%.Hubbard does a leveraged re chapiterization, way out debt and repurchasing bourgeon, until its debt=equity ratio is 0. 60. Due to the growingd risk, shareholders instantly expect a return of 13%. Assuming there are no evaluatees and Hubbards debt is risk free, what is the gratify rate on the debt? wacc = ru = 10% = 1 0. 6 x ? 1. 6(10) ? 13 = 3 = 0. 6 x ? x = 5% 13% + 1. 6 1. 6 14-17. Zelnor, Inc. , is an all-equity firm with degree Celsius million shares outstanding currently trading for $8. 50 per share. Suppose Zelnor decides to grant a rack up of 10 million unsanded shares to employees as fail of a unexampled compensation plan.The firm argues that this bran- red-hot compensation plan volition remind employees and is a better strategy that giving salary bonuses because it will not cost the firm anything. a. If the new compensation plan has no opinion on the revenue income revenue of Zelno rs assets, what will the share price of the new stock be once this plan is implemented? Assets = 850m. New shares = cx ? price = 850 = $7. 73 110 b. What is the cost of the plan for Zelnors investors? why is issuing equity costly in this case? Cost = 100(8. 50 ? 7. 73) = 77m = 10(7. 73) Issuing equity at below market place price is costly. MBA509RecommendedChapterQuestionsThesequestionsarethefocusofwhatIam bindingonthefinalexam. visualizetheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. Chapter 15 Debt and Taxes 15-1. Pelamed Pharmaceuticals has EBIT of $325 million in 2006. In addition, Pelamed has spare-time activity set downs of $125 million and a integrated valuate income rate of 40%. a. What is Pelameds 2006 net income? Net Income = EBIT affair Taxes = (325 125) x (1-0. 40) $120 million b. What is the total of Pelameds 2006 net income and kindle affordment? Net Income + Interest = 120 = 125 = $245 million c.If Pelamed had no interest expenses, what would its 2006 net income be? How does it compare to your answer in part (b)? NetIncome = EBIT ? Taxes = 325 ? (1 ? 0. 40) = $195 million This is 245 ? 195 = $50 million lower than part (b). d. What is the meat of Pelamedsinterest tax shield in 2006? Interest tax shield = 125 ? 40% = $50 million MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 15-3. Suppose the corporal tax rate is 40%.Consider a firm that earns$ kelvin originally interest and taxes distributively form with no risk. The firms capital expenditures equals its deprecation expenses each year, and it will take a crap no change to its net working capital. The risk-free interest rate is 5%. a. Suppose the firm has no debt and move overs out its net income as a dividend each year. What is the valuate of the firms equity? NetIncome = 1000 ? (1 ? 40%) = $600. Thus, equity holders contact di vidends of $600 per year with no risk. 600 E= = $12, 000 5% b. Suppose instead the firm makes interest coverments of $500 per year. What is the value of equity?What is the value of debt? 300 = $6000 5% Debt holders receive interest of $500 per year ? D $10,000 NetIncome ? (1000 ? 500) ? (1 ? 0. 40) = $300 ? E c. What is the difference betwixt the total value of the firm with leverage and without leverage? With Leverage = 6,000 + 10,000 = $16,000 Without Levergae = $12,000 Difference = 16,000 12,000 = $4000 d. The difference in part is equal to what percentage of the value of the debt? 4, 000 = 40% = corporate tax rate 10, 000 MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam.Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 15-6. Arnell Industries has $10 million in debt outstanding. The firm will net profit interest however on this debt. Arnells marginal tax rate is expected to be 35% for the foreseeable future day. a. Suppose Arnell pays interest of 6% per year on its debt. What is the annual interest tax shield? Interest tax sheild = $10 ? 6% ? 35% = $0. 21 million b. What is the present value of the interest tax shield, assuming its risk is the same as the loan? PV(Interest tax sheild) = $0. 21 = $3. 5 million 0. 06 c.Suppose instead that the interest rate on the debt is 5%. What is the present value of the interest tax shield in this case? Interest tax sheild = $10 ? 5% ? 35% = $0. one hundred s corey-five million $0. 175 = $3. 5 million PV = 0. 05 15-8. Rumolt Motors has 30 million shares outstanding with a price of $15 per share. In addition, Rumolt has issued bonds with a total current market value of 4150 MILLION. Suppose Rumolts equity cost of capital is 10%, and its debt cost of capital is 5%. a. What is Rumolts pretax weighted cost of capital? E = $15 ? 30 = $450m D = $150m Pretax WACC = 450 150 10% + 5% = 8. 75% 600 600 b.If Rumolts corporate rate is 35%, what is its after-tax weighted cost of capital? WACC = 450 150 10% = 5%(1 ? 35%) = 8. 3125% 600 600 MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 15-12. Milton Industries expects free cash flow of $5 million each year. Miltons corporate tax rate is 35%, and its unlevered cost of capital is 15%. The firm desirewise has outstanding debt of $19. 05 million, and it expects to find this train of debt permanently. a.What is the value of Milton Industries without leverage? VU = 5 = $33. 33 million 0. 15 b. What is the value of Milton Industries with leverage? V L = V U + ? c D = 33. 33 + 0. 35 ? 19. 50 = $40 million 15-13. Kurz Manufacturing is currently an all-equity firm with 20 million shares outstanding and a stock price of $7. 50 per share. Although investors currently expect Kurz to remain an all-equity firm, Kurz plans to announce that it will borrow $50 million and use the funds to repurchase shares. Kurz will pay interest only on this debt, and it has no hike up plans to ontogeny or decrease the amount of debt.Kurz is subject to a 40% corporate tax rate. a. What is the market value of Kurzs existing assets in the beginning the announcement? Assets = Equity = $7. 50 ? 20 = $150 million b. What is the market value of Kurzs assets (including the tax shield) just after the debt is issued, but before the shares are repurchased? Assests = 150 (existing) + 50 (cash) + 40% ? 50 (tax sheild) = $220 million c. What is Kurzs share price just before the share repurchase? How numerous Shres will Kurz repurchase? E = Assets ? Debt = 220 ? 50 = $ clxx million $ clxxm = $8. 50 parcel of land hurt = 20 50 = 5. 882 million shares Kurz will repurchase 8. 50 d.What are Kurzs market value counterpoise canvass and share price after the share repurchase? Assets ? 150(existing ) + 40% ? 50(taxsheild ) = $170 million Debt = $50 million E = A ? D = 170 ? 50 ? $ 120 million $120 = $8. 50 / share Share price = 20 ? 5. 882 MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 15-15. Suppose the corporate tax rate is 40%, and investors pay a tax rate of 15% on income from dividends or capital gains and a tax rate of 33. 3% on interest income.Your firm decides to add debt so it will pay an additional $15 million in interest each year. It will pay this interest expense by cut upting its dividend. a. How a great deal will debt holders receive after paid taxes on the interest they earn? $15 ? (1 ? 0. 333) = $10 million each year b. By how much will the firm need to cut its dividend each year to pay this interest expense? Given a corporate tax rate of 40%, an interest expense of $15 million per year tighten ups net income by 15(1-0. 4)=$9 million after corporate taxes. c. By how much will this cut in the dividend reduce equity h olders annual after-tax income? $9 million dividend cut ? 9 ? (1 ? 0,15) ? $7. 65 million per year d. How much little will the government receive in total tax revenues each year? Interest atxes = 0. 333 ? 15 = $5 million Less corporate taxes = 0. 40 ? 15 = $6 million Less dividend taxes = 0. 15 ? 9 = $1. 35 million note this equals (a) (c) e. What is the strong tax advantage of debt ? * ? (1 ? 0. 40)(1 ? 0. 15) ? * = 1? = 23. 5% 1 ? 0. 333 15-16. Markum Enterprises is considering permanently adding $100 million of debt to its capital structure. Markums corporate tax rate is 35%. a. Absent personal taxes, what is the value of the interest tax shield from the new debt?PV = ? c D = 35% ? 100 = $35 million b. If investors pay a tax rate of 40% on interest income, and a tax rate of 20% on income from dividends and capital gains, what is the value of the interest tax shield from new debt? ? * = 1? (1 ? 0. 35)(1 ? 0. 20) = 13. 33% 1 ? 0. 40 PV = ? C D = 13. 33% ? 100 = $13. 33 million M BA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 15-19. With its current leverage, Impi breadbasket will have net income next year of $4. million. If Impis corporate tax rate is 35% and it pays 8% interest on its debt, how much additional debt can Impi issue this year and still receive the benefit of the interest tax shield next year? Net income of $4. 5 million ? 4. 5 = $6. 923 million in taxable income. Therefore, Arundel can amplify its interest expense by $6. 923 million, which corresponds to debt of 6. 923 = $86. 5 million 0. 08 MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam.Chapter 16 Financial Distress, managerial Incentives and Information 16-2. Baruk Industries has no cash and a debt obligation of $36 millionthat is now due. The m arket value of Baruks assets is $81 million, and the firm has no liabilities. Assume a perfect capital market. a. Suppose Baruk has 10 million shares outstanding. What is Baruks current share price? 81 ? 36 = $4. 5 / share 10 b. How many new shares mustiness Baruk issue to raise the capital needed to pay its debt obligation? 36 = 8 million shares 4. 5 c. After repaying the debt, what will Baruks share price be? 81 = $4. 5 / share 18 16-3.When a firm defaults on its debt, debt holders oft receive less than 50% of the amount they are owed. Is the difference between the amount debt holders are owed and the amount they receive a cost of nonstarter? No. Some of these losses are due to declines in the value of the assets that would have occurred whether or not the firm defaulted. Only the incremental losses that arise from the bankruptcy process are bankruptcy costs. 16-4. Which type of firm is more seeming to experience a loss of customers in the event of monetary affliction a. Ca mpbell Soup Company or Intuit, Inc.? Intuit Inc. its customers will care about their ability to receive upgrades to their packet. b. Allstate Corporation or Reebok planetary? Allstate Corporation its customers rely on the firm being able to pay future claims. MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 16-5. Which type of assets is more likely to be liqui ensured for close to its honorable market value in the event of financial detriment? a. An office construction or a brand name?Office buildingthere are many alternate users who would be likely to value the blank space similarly. b. Product inventory or raw materials? Raw materialsthey are easier to reuse. c. unmistakable right of engineering know-how? Patent rightsthey would be easier to sell to another firm. 16-9. Marpor Industries has no debt and expects to turn over free cash flows of $16 millio n each year. Marpor recalls that if it permanently increases its level of debt to $40 million, the risk of financial distress may cause it to lose some customers and receive less favorable terms from its suppliers.As a result, Marpors free cash flows with debt will be only $15 million per year. Suppose Marpors tax rate is 35%, the risk-free rate is 5%, the expected return of the market is 15%, and the important of Marpors free cash flows is 1. 1. (with or without leverage). a. Estimate Marpors value without leverage r = 5% + 1. 1? (15% ? 5%) = 16% 16 V= = $100 million 0. 16 b. Estimate Marpors value with the new leverage. r = 5% + 1. 1? (15% ? 5%) = 16% 15 V= + 0. 35 ? 40 = $107. 75 million 0. 16 MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam.Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 16-10. Real Estate Purchases are often financed with at least 80% debt. Most corporations, however, have less that 50% debt financing. Provide an explanation for this difference exploitation the trade-off possible action. consort to tradeoff theory, tax shield adds value while financial distress costs reduce a firms value. The financial distress costs for a real estate investment are likely to be low, because the property can generally be easily resold for its full market value.In contrast, corporations generally face much blueer costs of financial distress. As a result, corporations choose to have lower leverage. 16-11. Dynron Corporations primary stackiness is natural gas transportation using its broad gas pipeline network. Dynrons assets currently have a market value of $150 million. The firm is exploring the possibility of raising $50 million by selling part of its pipeline network and place the $50 million in a fiber-optic network to generate revenues by selling high-speed network bandwidth.While this new investment is expected to increase profits, it will also substantially increase Dy nrons risk. If Dynron is levered, would this investment be more or less attractive to equity holders than if Dynron had no debt? If Dynron has no debt or if in all scenarios Dynron can pay the debt in full, equity holders will only consider the projects NPV in making the decision. If Dynron is heavily leveraged, equity holders will also gain from the increased risk of the new investment. 16-18. Which of the following industries have low optimal debt levels according to the tradeoff theory? Which have high optimal levels of debt? a.Tobacco firms high optimal debt levelhigh free cash flow, low growth opportunities Accounting firms low optimal debt levelhigh distress costs Mature eatery chains high optimal debt levelstable cash flows, low growth, low distress costs Lumber companies high optimal debt levelstable cash flows, low growth, low distress costs booth phone manufacturers low optimal debt levelhigh growth opportunities, high distress costs b. c. d. e. MBA509RecommendedChapterQu estions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 6-19. According to the managerial entrenchment theory, managers choose capital structures so as to preserve their direct of the firm. On the one hand, debt is costly for managers because they risk losing control in the event of default. On the other hand, if they do not take advantage of the tax shield provided by debt, they risk losing control through a hostile takeover. Suppose a firm expects to generate free cash flows of $90 million per year, and the discount rate for these cash flows is 10%. The firm pays a tax rate of 40%. A marauder is poised to take over the firm and finance it with $750 one thousand thousand in permanent debt.The raider will generate the same free cash flows, and the takeover attempt will be successful if the raider can offer a premium of 20% over the current value of the firm. What level of permanent debt will the firm choose, according to the managerial entrenchment hypothesis? 90 = $900 0. 10 Levered value w/ brigand = 900 + 40%(750) = $1. 2 billion To prevent successful raid,l current managment must have a levered value of at least $1. 2 billion = $1 billion 1. 20 Thus, the minimum tax sheild is $1 billion 900 million = $100 million, 100 which requires = $250 million in debt 0. 40 Unlevered Value = MBA509RecommendedChapterQuestionsThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. Chapter 17 Payout Policy 17-6. The HNH Corporation will pay a constant dividend of $2 per share, per year, in perpetuity. Assume all investors pay a 20% tax on dividends and that there is no capital gains tax. The cost of capital for investing in HNH stock is 12%. a. What is the price of a share of HNH stock? P=$1. 60/0. 12=$13. 33 b. Assume that management make a surprise announcement that HNH will no longer pay dividen ds but will use the cash to repurchase stocks instead.What is the price of a share of HNH stock now? P=$2/0. 12=$16. 67 17-7. What was the feative dividend tax rate for a U. S. investor in the highest tax support who planned to hold a stock for one year in 1981? How did the rough-and-ready dividend tax rate change in 1982 when the Reagan tax cuts took effect? (Ignore State taxes. ) 58. 33% in 1981 and 37. 5% in 1982. 17-10. At current tax rates, which investors are most likely to hold a stock that has a high dividend yield? a. Individual Investors b. Pension Funds c. joint Funds d. Corporations 17-11. A stock that you know is held by long-run respective(prenominal) investors paid a large one-time dividend.You notice that the price dropped on the ex-dividend date is about the size of the dividend payment. You find this relationship puzzling given the tax disadvantage of dividends. Explain how the dividends-capture theory mogul account for this behavior. Dividend capture theory states that investors with high effective dividend tax rates sell to investors with low effective dividend tax rates just before the dividend payment. The price drop therefrom reflects the tax rate of the low effective dividend tax rate individuals. MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam.Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. 17-16. Explain under which conditions an increase in the dividend payment can be interpreted as a signal of a. Good news By increasing dividends managers signal that they believe that future earnings will be high enough to maintain the new dividend payment. b. Bad news Raising dividends signals that the firm does not have any positive NPV investment opportunities, which is bad news. 17-17. Why is an announcement of a share repurchase considered a positive signal?By choosing to do a share repurchase management credibly signals that they believe the stock is undervalued . 17-20. Explain why most companies choose to pay stock dividends (split their stock). Companies use stock splits to keep their stock prices in a range that reduces investor achievement costs 17-21. When might it be advantageous to undertake a lapsing stock split? To avoid being delisted from an exchange because the price of the stock has fallen below the minimum required to stay listed. 17-22. After the market close on may 11, 2001, Adaptec, Inc. , distributed a dividend of shares of he stock of its software division, Roxio, Inc. Each, Adaptec shareholder received 0. 1646 share of Roxio stock per share of Adaptec stock owned. At the time Adaptec stock was trading at a price of $10. 55 per share (cum-dividend), and Roxies share price was $14. 25 per share. In a perfect market, what would Adaptecs ex-dividend share price be after this act? The value of the dividend paid per Adaptec share was (0. 1646 shares of Roxio) ? ($14. 23 per share of Roxio) = $2. 34 per share. Therefore, i gnoring tax effects or other news that might come out, we would expect Adaptecs stock price to fall to $10. 5 2. 34 = $8. 21 per share once it goes ex-dividend. (Note In fact, Adaptec stock opened on Monday May 14, 2001 the next trading day at a price of $8. 45 per share. ) MBA509RecommendedChapterQuestions ThesequestionsarethefocusofwhatIamcoveringonthefinalexam. Understandtheanswerstothesequestionsandshouldnotbesurprisedbyanythingontheexam. Explain the semipermanent (3 to 5 years) relative stock performance of companies that have i) issued a seasoned equity offering ii) split their stocks Why would a stock split be a signal for good news?What is meant by leaving money on the table, when issuing an IPO? Why might issuing management be content to leave a lot of money on the table? Can you spot the period of a stock market bubble in the table below? (Hint come along for an oval ) In retrospect, do you think it is a good long-term investment to purchase stocks where there has bee n huge amounts of money left on the table? Table 1 Summary Statistics for 6,312 IPOs with Offer Price ? $5. 00 think about First-day Return 7% 15% 65% 12% 19% Average, 2001 Dollars coin Left on the Table Gross Proceeds $2. million $10 million $82 million $29 million $17 million $42 million $72 million $161 million $397 million $81 million Period 1980-1989 1990-1998 1999-2000 2001-2002 1980-2002 Describe how investment banks allocate IPO shares using the bookbuilding method. Are IPOs, as a group and over time, good long-term investments in terms of average annual returns? Describe how IPOs are like Lotto tickets. (Low expected returns, but with relatively low probability of exceedingly large gainsbuying into Microsoft, Intel, etc) Hint this is the answer.Describe Graham and Kumars suggestive raise that there is, indeed, a backup effect for dividends. Which class of investors like high dividend yields? Which age bracket? How do these finding suggest a clientele effect? Chapter14. CapitalStructureinaPerfectMarket Summary 1. Thecollectionofsecuritiesafirmissuestoraisecapitalfrominvestorsiscalledthe firmscapitalstructure. Equityanddebtarethesecuritiesmostcommonlyuseby firms. Whenequityisusedwithoutdebt,thefirmissaidtobeunlevered. Otherwise,the amountofdebtdeterminesthefirmsleverage. . Theownerofafirmshouldchoosethecapitalstructurethatmaximizesthetotalvalue ofthesecuritiesissued. 3. Capitalmarketsaresaidtobeperfectiftheysatisfythreeconditions a. Investorsandfirmscantradethesamesetofsecuritiesatcompetitivemarket pricesequaltothepresentvalueoftheirfuturecashflows. b. Therearenotaxes,transactioncosts,or topiccostsassociatedwithsecurity trading. c. Afirmsfinancingdecisionsdonotchangethecashflowsgeneratedbyits investments,nordotheyrevealnewinformationaboutthem. 4.AccordingtoMMPropositionI,withperfectcapitalmarketsthevalueofafirmis independentofitscapitalstructure. a. Withperfectcapitalmarkets, homespunleverageisaperfectsubstituteforfirm leverage. b. Ifotherwiseident icalfirmswithdifferentcapitalstructureshavedifferentvalues, theLawofOnePricewouldbeviolatedandanarbitrageopportunitywould exist. 5. Themarketvaluebalancesheetshowsthatthetotalmarketvalueofafirmsassets equalsthetotalmarketvalueofthefirmsliabilities,includingallsecuri tiesissuedto investors.Changingthecapitalstructurethereforealtershowthevalueoftheassetsis dividedacrosssecurities,butnotthefirmstotalvalue. 6. Afirmcanchangeitscapitalstructureatanytimebyissuingnewsecuritiesandusing thefundstopayitsexistinginvestors. Anexampleisaleveragedrecapitalizationin whichthefirmborrowsmoney(issuesdebt)andrepurchasesshares(orpaysa dividend). MMPropositionIimpliesthatsuchtransactionswillnotchangetheshare price. 7. AccordingtoMMPropositionII,thecostofcapitalforleveredequityis 8. Debtisless unsafethanequity,soithasalowercostofcapital.Leverageincreasestherisk ofequity,however,raisingtheequitycostofcapital. Thebenefitofdebtslowercostof capitalis kickoffbythehigherequitycostofcapital,leavingafirmsweight edaverage costofcapital(WACC)unchangedwithperfectcapitalmarkets 1 9. Themarketriskofafirmsassetscanbeestimatedbyitsunleveredbeta 10. Leverageincreasesthebetaofafirmsequity 11. Afirmsnetdebtisequaltoitsdebtlessitsholdingsofcashandotherrisk? free securities. Wecancomputethecostofcapitalandthebetaofthefirmsbus