Question 1 (Q1) The basic theory of capital structure In perfect capital markets, what is the relationship between capital structure and cost of capital (WACC)? Apply the famous Miller-Modigliani propositions to BT's case and explain how a different capital structure may or may not affect its market value.

Tips: 1. Complete the table in Excel spreadsheet Q1 Perfect Mkt.

		Current	Different levels of debt for share repurchase
Additional long-term debt to raise		0	2,000	4,000	5,000	6,000	7,000
Net Debt (D)
Market Value of Equity
Total market value of assets (= D+E)
D/(D+E)
E/(D+E)
rE (See spreadsheet Other Info)
rD (See spreadsheet Credit Rating)
rU
share price
Number of shares outstanding

2. Draw a chart using debt level (D) against rE and WACC to support the discussion of MM proposition I and II. (Paste the chart)

3. Show your calculations for each variable in row (6) to (15) (above image) using debt = $3 billion.

Other information: Propose tax rate: 25%

Market risk premium = (rm - rf) = 7%

Rf = 4.86

cost of debt = 9.307%

While figures given in financial statements are in thousands, for simplicity, all numbers you calculate in the spreadsheet (Q1 to Q4) should be in millions with no decimal place, except for percentages and share prices, where two decimal places are needed.

Income statement
(in thousands, except per share amounts)
	2021	2020	2019
EARNINGS
Net sales	$ 34,29,646	$ 21,45,706	$ 20,61,602
Cost of sales	$ 9,97,054	$ 9,04,266	$ 9,04,183
Gross Profit	$ 24,32,592	$ 12,41,440	$ 11,57,419
Selling and general administrative expenses	$ 9,19,236	$ 7,78,197	$ 7,21,813
Operating income	$ 15,13,356	$ 4,63,243	$ 4,35,606
Investment income	$ 18,553	$ 19,185	$ 17,636
Other expense	$ (4,543)	$ (3,116)	$ (8,812)
Earnings before income taxes (EBIT)	$ 15,27,366	$ 4,79,312	$ 4,44,430
Income taxes (@25%)	$ 3,81,842	$ 1,19,828	$ 1,11,108
Net earnings	$ 11,45,525	$ 3,59,484	$ 3,33,323

Consolidated Balance Sheet
(in thousands of dollars)	2021	2020
ASSETS
Current assets:
Cash and equivalents	$ 2,21,946	$ 3,00,599
Short-term investments, at amortized cost	$ 25,450	$ 29,301
Accounts receivable
(less allowance for doubtful accounts: 2001 - $7,712, 2000 - $7,065)	$ 2,39,885	$ 1,91,570
Inventories
Finished goods	$ 75,693	$ 64,676
Raw materials and suppplies	$ 2,03,288	$ 1,88,615
	$ 2,78,981	$ 2,53,291
Other current assets	$ 46,896	$ 39,728
Deferred income taxes - current	$ 14,856	$ 14,226
Total current assets	$ 8,28,014	$ 8,28,715
Marketable equity securities, at fair value	$ 25,300	$ 28,535
Deferred charges and other assets	$ 1,15,745	$ 83,713
Deferred income taxes - non-current	$ 26,381	$ 26,743
Property, plant, and equipment (at cost)
Land	$ 2,19,312	$ 39,125
Buildings and building equipment	$ 3,59,109	$ 3,44,457
Machinery and equipment	$ 8,57,044	$ 7,56,050
	$ 14,35,465	$ 11,39,632
Less accumulated depreciation	$ 5,71,717	$ 5,32,598
Net, property plant and equipment	$ 8,63,748	$ 6,07,034
TOTAL ASSETS	$ 18,59,188	$ 15,74,740
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$ 91,223	$ 73,129
Short term debt	$ 2,21,948	$ 1,13,779
Dividends payable	$ 42,711	$ 39,467
Income and other taxes payable	$ 68,437	$ 60,976
Deferred income taxes - current	$ 1,455	$ 859
Total current liabilities	$ 4,25,774	$ 2,88,210
Deferred income taxes - non-current	$ 43,206	$ 40,144
Other non-current liabilities	$ 1,13,921	$ 1,13,489
Common stock (565.9 million shares outstanding)	$ 12,646	$ 12,558
Class B common stock (332.7 million shares outstanding)	$ 2,850	$ 2,938
Additional paid-in capital	$ 1,153	$ 346
Retained earnings	$ 16,84,337	$ 14,92,547
Treasury stock	$ (2,89,799)	$ (2,56,478)
Accumulated other comprehensive income	$ (1,34,900)	$ (1,19,014)
Total stockholders' equity	$ 12,76,287	$ 11,32,897
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$ 18,59,188	$ 15,74,740

Other information:

Company Name	Recent Price	Common Shares Outstanding (millions)	Market Value of Equity (millions)	Book Value of Equity (millions)	Total Long-term Debt (millions)
Pear Inc. HQ in Cupertino	$ 26.66	502.50	$ 13,397	$ 5,264	$ 2,264
Phoebes. HQ in Mountain View	$ 65.45	136.63	$ 8,942	$ 2,785	$ 869
Microtender. HQ in Redmond	$ 38.82	1,735.00	$ 67,353	$ 39,920	$ 8,548
Facegram. HQ in Menlo Park	$ 31.17	51.66	$ 1,610	$ 509	$ 840
Bell Technologies. HQ in Round Rock	$ 15.69	899	$ 14,099	$ 1,276	$ -
Company Name	Beta	EPS	Price/ Earnings	Cash Dividend	Dividend Payout ratio	Dividend Yield
Pear Inc. HQ in Cupertino	0.74	1.39	15.20	$ 0.67	44.0%	2.50%
Phoemes. HQ in Mountain View	0.90	2.74	20.40	$ 1.16	41.0%	2.00%
Microtender. HQ in Redmond	0.70	1.17	18.70	$ 0.26	12.0%	1.50%
Facegram. HQ in Menlo Park	0.65	1.30	24.00	$ 0.28	22.0%	0.90%
Bell Technologies. HQ in Round Rock	0.81	1.27	12.31	$ 0.10	46.0%	0.64%