Company Wii gives you the following information for its operation. The expected income available for dividends is $42 million next year before the firm has any debts. Suppose there is a 25% corporate income tax imposed on the company. Company Wii has no debt originally. There are 6 million shares of common stocks outstanding. Let the market price for the stock be $42.5 per share before debt. Suppose that there is no expansion plan for the company to either spend on working capital vs. long-term investment or to apply the accumulated retained earning. Answer the following questions:
a) What is the possible dividend per share for the common stock before company Wii has debt? What is the cost of equity for Company Wii’s stock before debt? Suppose that Company Wii now has issued some bonds with 6% coupon rate recently. Let Company Wii’s total debts (with the above coupon bond) be $80 million and let this coupon rate represent the cost of debt, how much will be the value of stockholders’ equities under Modigliani and Miller’s proposition 2?
b) What is the cost of equity for Company Wii, if there’s no preferred stock issued for this company?
c) What is the weighted average cost of capital after Company Wii has debts?
d) Suppose the risk-free rate is 2%, S&P 500 index return is 12%, what is the “beta” of Company Wii’s common stock after issuing debts?
e) What are the limitations of M&M proposition 2?