Question

the common stock and debt of northern sludge are valued at $64 million and $36 million, respectively. investors currently require a return of 16.6% on the common stock and 7.1% on the debt. if northern sludge issues an additional $16 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. (do not round intermediate calculations. enter your answer as a percent rounded to 2 decimal places.)'

Answer 1

The expected return on the common stock should decrease.

To calculate the new expected return on the common stock, we need to calculate the new value of the common stock and debt. The new value of the common stock is $64 million + $16 million = $80 million. The value of the debt is reduced by $16 million to $20 million.

The new expected return on the common stock is 16.6% * ($80 million/$96 million) = 15.63%.

Therefore, the expected return on the common stock should decrease from 16.6% to 15.63%.

A security that symbolises ownership in a firm is called common stock. Common stock owners choose the board of directors and cast ballots for corporate rules. Long-term rates of return are often higher with this type of stock ownership.

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