1. **Hartford Mining has 90 million shares that are currently trading for $2 per share and $160 million worth of debt. The debt is risk free and has an interest rate of 4%, and the expected return of Hartford stock is 11%. Suppose a mining strike causes the price of Hartford stock to fall 25% to $1.50 per share. The value of the risk-free debt is unchanged. Assuming there are no taxes and the risk (unlevered beta) of Hartford’s assets is unchanged, what happens to Hartford’s equity cost of capital?**

2. **Hubbard Industries is an all-equity firm whose shares have an expected return of 10.9%. Hubbard does a leveraged recapitalization by issuing debt and repurchasing stock until its debt-equity ratio is 0.66. Due to the increased risk, shareholders now expect a return of 17.1%. Assuming there are no taxes and Hubbard’s debt is risk-free, what is the interest rate on the debt?**

3. **Global Pistons (GP) has common stock with a market value of $470 million and debt with a value of $299 million. Investors expect a 13% return on the stock and a 5% return on the debt. Assume perfect capital markets.**

a. **Suppose GP issues $299 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 $71 million of new debt to repurchase stock.**

i. **If the risk of the debt does not change, what is the expected return of the stock after this transaction?**

**ii. If the risk of the debt increases, would the expected return of the stock be higher or lower than in part (i)?**

4. **Suppose Alpha Industries and Omega Technology have identical assets that generate identical cash flows. Alpha Industries is an all-equity firm, with 14 million shares outstanding that trade for a price of $24 per share. Omega Technology has 22 million shares outstanding as well as debt of $100 million.**

a. **According to MM Proposition I, what is the stock price for Omega Technology?**

b. **Suppose Omega Technology stock currently trades for $15 per share. What arbitrage opportunity is available? What assumptions are necessary to exploit this opportunity?**

5. **Wolfrum Technology (WT) has no debt. Its assets will be worth $444 million in one year if the economy is strong, but only $226 million in one year if the economy is weak. Both events are equally likely. The market value today of its assets is $257 million.**

a. **What is the expected return of WT stock without leverage?**

b. **Suppose the risk-free interest rate is 5%. If WT borrows $52 million today at this rate and uses the proceeds to buy back its equity, what will be the market value of its equity just after this transaction, according to MM?**

c. **What is the expected return of WT stock after the transaction in part (b)?**

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January 31, 2023

January 31, 2023