Problem 1: (20 marks)

Williams Inc is an all equity financed firm operating in Nova Scotia. The firm has 1,000,000 shares outstanding trading for $25 per share. Additionally, the firm plans to pay all its future earnings as cash dividends to its shareholders.

The current return on Government of Canada T-Bills is 2%, the return on the market portfolio is 10% and Williams estimated beta is 1.20.

Part 3: Consider a world with taxes and costs for the risk of financial distress. The tax rate is 40%. Assume the market value of the equity is the same as you calculated in part (a) above.

Williams Inc. is now trying to determine whether they should borrow $1,000,000 and repurchase shares

Value of debt	RD	PV of distress costs
$0	-	-
$1,000,000	7%	$600,000

1. Now what is the value of the firm if they issue $1,000,000 in debt? (1 marks)

2. What is the optimal capital structure for Williams Inc. : $0 or $1,000,000 in debt? Explain in words supported by the numbers. (2 mark)