1) Sam Corporation is financed by common stock holders and has the beta of 1.0 the firm is expected to create the level perpetual stream of earnings and dividends. Stock has the price-earnings ratio of 8 and the cost of equity of 12.5% company's stock is selling for $50 dollars. Now firm decides to repurchase half of its shares and substitute the equal value of debt. Debt is risk free, with 5% interest rate. Company is exempt from corporate income taxes. Supposing MM theory is right Compute the following items?
a) The cost of equity
b) Overall cost of capital (WACC)
c) Price/Earning ratio
d) Stock Price
e) Stock Beta
2) MM theory Proposition 1-
Executive Chalk is financed exclusively by common stock and has 25 million outstanding shares with the market price of= 10 dollars per share. It now publicizes that it is going to issue 160 million dollars of debt and use proceeds to buy back common stock.
a) By using MM theory proposition 1 how is market price of stock affected by announcement?
b) How many shares can a company buy back with 160 million dollars of debt which it issues?
c) Determine the market value of firm (equity plus debt) after changing the capital structure?
d) What is the new debt ratio after a change in structure?
e) Who (if anyone) gains or losses?