Chapter 14
2. What is the total market value of the firm without leverage?
a. Without leverage = 2*2 m = 4,000,000 million (total market value)
b. Suppose you borrow 1 million. According to MM, what fraction of the firm’s equity will you need to sell to raise an additional 1 million you need?
“ As long as the firms choice of securities does not change the cash flows generated by its assets must have the same total market value” ( Berk & DeMarzo, 2010, pg. 455).
Therefore, the total value of the firm is still 4 million dollars. Because they borrowed 1 million they have 1 million of debt and 3 million of equity. 1/3 = 33% of equity must be sold in order to raise a million dollars.
c. What is the value of your share of the firm’s equity in cases a and b ?
Case A: 50% * 4 million = 2 million
Case B: 2/3 * 3 million = 2 million
4a. Expected return without leverage: .5 * 450 + .5 * 200 = 325 / 250 = 1.30 expected return without leverage = 30%
4b. What will be the market value of its equity just after the dividend is paid according to MM?
E + D = 250 ; D = 100 ; E + 100 = 250 ; 250 – 100 = 150 ; E = 150
4c. What is the expected return of MM stock after the dividend is paid in part b?
.5 * 450- 105 + .5 (200 – 105) = 172.50 + 47.5 = 220 /150 = 1.4666666
The expected return of MM stock after dividend is paid would be 46.67
14a. Suppose GP issues 50 million of new stock to buy back the debt. What is the expected return of the stock after this transaction?
2(.15) / 3 + .6/3 = 12% Expected Return = 12%
14b. Suppose instead GP issues 50 million of new debt to repurchase stock.
If the risk of the debt does not change what is the expected return of the stock after this transaction?
12 + 150 (12 – 6) / 150 = 18%

If the risk of the debt increases, would the expected return of the stock be higher or lower than in part a? I think that if the risk