Question: Question 4 [15 Points]: XYZ Inc. does not have a target debt-to-value ratio, but it has $1.5 .. q ' free debt in its capital

Question 4 [15 Points]: XYZ Inc." does not have a target

Question 4 [15 Points]: XYZ Inc." does not have a target debt-to-value ratio, but it has $1.5 .. q ' free debt in its capital structure (which was supposed to remain at: forever). Debt is trading at par and has a coupon rate of 3%. Market V951, _ is $4 million and there are 100,000 shares outstanding. You can assume , '_ has only debt and equity in its capital structure and therefore its total marke va is $5 million. Debt is 20% of total market value of the rm. Beta (El) for: X'Y" equity is currently 1.2. A new management team has replaced the old management, and the new team , XYZ is planning to adopt a new policy regarding its debt and it wants to have a x . target debt-to-value ratio of 25%. In order to achieve the new target level of debt; * the management of XYZ is planning to issue some new debt and it has announced * that the new debt will be used to buy back some shares and it will not be used for any new investment. Analysts have said that debt will still be risk-free. The corporate tax rate for XYZ is 30%. There are no personal taxes. If XYZ issues additional debt in order to achieve the target level of debt, then (a) How much new debt should be issued? (1)) What will be the new rm value according to Modigliani-Miller's theory in the presence of corporate taxes? (C) What is your estimate of the equity Beta (Dafter the issuance of the new debt? ((1) What will be the new share price? (A word of caution: When additional debt is issued, the rm value will change from its current $5 million because of additional tax shield created by the new debt.) 1

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