Question: Question 2 40 pts Alpaca Wools plc is planning to repurchase part of its ordinary share equity by issuing corporate debt. As a result, the

Question 2 40 pts Alpaca Wools plc is planning to repurchase

Question 2 40 pts Alpaca Wools plc is planning to repurchase part of its ordinary share equity by issuing corporate debt. As a result, the debt to equity ratio is expected to rise from 10% to 30%. The company currently has 3million of debt outstanding. The cost of this debt is 15% per year. Alpaca Wools plc is expected to have EBIT of 2m per year in perpetuity. Since Alpaca is a startup business it pays no taxes. REQUIRED: (a) What is the market value of Alpaca Wools plc before and after the share repurchase announcement? Assume M&M I holds. (10 marks) (b) What is Alpaca Wool's expected return on equity before the announcement of the share repurchase plan? (8 marks) (c) What is the expected return on the equity of an otherwise identical all equity firm? (10 marks) (d) What is the expected return on Alpaca Wool's equity after the announcement of the share repurchase plan? (8 marks) (e) If Alpaca Wools PLC has a Beta of 1.5, and the equity risk premium is 2%, what is the risk free rate using the expected return in b)? (4 marks) (Total 40 marks)

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