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Section 2: Capital Structure An unlevered company operates in perfect markets and has earnings before interest and...

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Finance

Section 2: Capital Structure

  1. An unlevered company operates in perfect markets and hasearnings before interest and taxes (EBIT) of $3m. Assume that therequired return on assets for firms in this industry is 10%. Thefirm issues $15m worth of debt with a required return of 6% anduses the proceeds to repurchase outstanding stock. There are nocorporate or personal taxes.
    a) What is the market value of the firm and required return of thisfirm’s stock before the repurchase transaction, according to M& M Proposition I?
    b) What is the market value of the firm and the required return andthe required return on the firms remaining stock after therepurchase transaction, according to M & M PropositionII?

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