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 2: Consider a world with taxes but no bankruptcy costs. The tax rate is 40%.

Assume the market value of the equity is the same as you calculated in part (a) above.

1. What would be the market value of Williams Inc if it plans to add $1,000,000 of debt with a coupon rate of 5% to its capital structure? Debt will be sold at par value and will be used to repurchase shares. The tax rate is 40%. (2 mark)

2. What would be the cost of equity of Williams Inc if it plans to add $1,000,000 of debt with a coupon rate of 5% to its capital structure? Debt will be sold at par value and will be used to repurchase shares. (2marks)

3. What would be the WACC of Williams Inc if it plans to add $1,000,000 of debt with a coupon rate of 5% to its capital structure? Debt will be sold at par value. (2 marks)

4. Now what is the optimal capital structure for Williams Inc? Explain in words and state why. (4 mark)