Answer Happy

5. Capital Structure Decision [25 Marks] Shire plc currently is all-equity-financed. The company currently has 10 million shares outstanding, selling at £100 per share. The return on equity is 12%. The firm is considering a capital restructuring. The plan calls for a debt issue of £200 million permanently with the proceeds used to buy back stock. The debt will pay an interest rate of 10%. Shire has had consistently stable earnings and pays a 21% tax rate. Answer the following questions using the Modigliani-Miller (1963) theory with corporate taxes. ECO-20051 Finance 2 5/6 a) Calculate the firm market value after the announcement of the capital restructuring and the number of shares that can be repurchased. [6 Marks] b) Calculate the cost of equity capital and the firm's WACC after the repurchase [4 Marks] c) Discuss the changes in the cost of equity and the WACC based on your answers in 3) and relate it to MM (1963) proposition II. Illustrate your discussion with a relevant graph. [10 Marks] d) List the assumptions that lie behind the Modigliani-Miller theory in a world with corporate taxes. [5 Marks]