Copperhead Corporation currently has debt $ 2,000,000, and 4 million shares of the common stock outstanding with a market value of $2 per share. Mary’s portfolio consists of 50, 000 shares of Copperhead Corporation’ common stock and $ 100,000 on the riskfree asset. Copperhead now announces that it will borrow an additional $ 1 million on a permanent basis through a leveraged recapitalization in which it will use the borrowed funds to repurchase outstanding shares. The debt of Copperhead is risk-free before and after the change of capital structure.

Assuming the corporate tax rate is zero (before and after the capital structure change), do subquestions i)-ii).

i) What is the stock price of Copperhead after its capital structure changes?

ii) How does Mary adjust her portfolio to make her position same as before (i.e., to achieve the same expected return of portfolio as before)?

Assuming that the corporate tax rate is 50% (before and after the capital structure change), do subquestions iii)-iv).

iii) What is the stock price of Copperhead after its capital structure changes?

iv) The risk-free return is 6% and the beta of Copperhead’s equity before the capital structure change is 2. The market return is 8%. How does Mary adjust her portfolio to 4 make her position same as before (i.e., to achieve the same expected return of portfolio as before)?

Answer rating: 100% (QA)

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