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Question 3 (total of 12 marks): For each of the following events, state the effect on the market value of the firms levered assets (), cost of debt , cost of equity , weighted average cost of capital after tax, weighted average cost of capital before tax, and market value of levered equity ().

Important assumptions: The risky firm's levered assets currently have the same systematic risk as the market portfolio, all events happen in isolation and are a surprise, and all transactions are done at a fair price. Assume a corporate tax rate of 30%, but there are no transaction costs, no asymmetric information (so ignore signalling effects), and no change in the credit risk of the firm's debt.

options for each answer: increase, decrease, unchanged

Firm value Cost of debt Weighted System-atic risk Num shares (n) average cost of of the firm's capital (after tax) assets (BVL) VL Issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firm's usual investments . > > Issues bonds and uses the proceeds to repurchase shares. The corporate tax rate suddenly decreases by a material amount. Conducts a 3-for-1 rights issue at a significant discount to the current market share price Invests in a lower than average risk project with a positive NPV, funded half with a bank loan and half with a share issue. . Unexpectedly generates larger than usual cash flows and uses those cash flows to repay debt. . Conducts a 2 for 1 share split Firm value Cost of debt Weighted System-atic risk Num shares (n) average cost of of the firm's capital (after tax) assets (BVL) VL Issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firm's usual investments . > > Issues bonds and uses the proceeds to repurchase shares. The corporate tax rate suddenly decreases by a material amount. Conducts a 3-for-1 rights issue at a significant discount to the current market share price Invests in a lower than average risk project with a positive NPV, funded half with a bank loan and half with a share issue. . Unexpectedly generates larger than usual cash flows and uses those cash flows to repay debt. . Conducts a 2 for 1 share split

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