Suppose that a firm is an all-equity firm. Its current annual operating cash flows are $27 million, perpetually. It has 10 million shares outstanding. The current required rate of return on equity is 10%. It is considering a new investment of similar risk with initial outlay of $20 million, and added annual operating cash flows of $3 million, perpetually.
- What will the total MV of the firm be if common stock is used to finance the investment?
- What if $20 million of perpetual, 8% coupon bonds are issued to finance the investment?
- Suppose that it issues the bonds. What is the new cost of equity capital?