- Company JJ gives you the following information for its operation. The expected profit (before tax) is $60 millions next year. Suppose there is a 35% corporate income tax imposed on the company. Company JJ has no debt originally. There are 8 million shares of common stocks outstanding. Let the current market price for the stock be $25 per share. 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) Suppose that Company JJ also has issued some 5-year coupon bonds recently. The bond carries 6% coupon with $1,000 par value. Let the current bond price be $700 per bond, what is the yield to maturity for this bond? What are the assumptions you make here? Is there any limitation for this model?
- b) Let Company JJ’s total debts on coupon bond be $70 millions. How much will be the value of stockholders’ equities under Modigliani and Miller’s proposition?
- c) What is the cost of equity for Company JJ, if there’s no preferred stock issued for this company?
- d) What is the weighted average cost of capital after Company JJ has debts?
- e) Will the application of debts increase the “beta†of Company JJ’s common stock? Why or why not? (Note: You don’t need to calculate it. Just explain the reasons).
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