1. Capital Structure (20 points; AB, 5 points; C, 10 points)

Gentrix Inc. has two major sources of financingcommon stock and long-term debt. They currently have 1,000,000 shares of stock outstanding, which are trading at a price of $20 per share.

Two years ago, they issued $5,000,000 of 20-year debt to the general public at par value. The debt pays an annual coupon of 7%.

Given their current capital structure, Gentrix has estimated that their cost of equity is 15%.

Gentrix faces a marginal tax rate of 40%.

1. It has been exactly two years since Gentrix issued their debt, and interest rates have increased. If the long-term debt is currently yielding 9%, what is the current value of the outstanding debt? Is it selling at a premium or discount to par value? (For simplicity, you may assume that coupon payments of 7% are made annually rather than the semiannually.)

2. Based on Gentrixs current capital structure, what is the firms weighted average cost of capital?

3. Assume that Gentrix currently has a capital structure that is 80% equity and 20% debt. The firm has decided to issue debt to retire equity such that their resulting capital structure is 60% equity and 40% debt. The firm has determined that they can comfortably afford the higher debt levels without any material effect on their competitiveness or financial condition. Once the capital structure is changed, what will happen to: (1) their cost of equity, (2) the price of their stock, and (3) their weighted average cost of capital? Explain. (You may use calculations to support your answer, but you are not required to do so.)