MTM is an all-equity firm with expected cash flow of $450,000 per year forever. There are 100,000 shares outstanding. The unlevered cost of capital is 15%. MTM wants to build a new plant for $400,000. The plant is expected to generate additional cash flow of $150,000 per year in perpetuity. The expansion has the same risk as the existing assets. Assume an M&M no tax world.
1. Prior to the expansion, what is the value of the original assets? Equity? Find the stock price.
2. Suppose the plant is financed with stock. How many shares must be issued? What is the value of the equity and the stock price after the issue?
3. Suppose the plant is financed with bonds that have an interest rate of 10%. After the bond issue, what is the value of the firm? Of the equity? What is the stock price?
4. Calculate expected return on equity using M&M No Tax II.