Question 1: Global Pistons has common stock with a market value of $200 million and debt with value of $100 million.
Investors expect a 15% return on the stock and a 6% return on the debt. Assume perfect capital markets.
a) Suppose GP issues $100 million of new stock to buy back the debt. What is the expected return of the stock after this transaction?
b) Suppose instead GP issues $50 million of new debt to repurchase stock.
If the risk of the debt doesn't change what is the expected return of the stock after this transaction?
Question 2: Your fim currently has $100 million in debt outstanding with a 10% interest rate. The terms of the loan require the firm to repay $25 million of the balance each year.
Suppose that the marginal corp tax rate is 40% and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt?