Suppose a company is financed with $20 million of equity and $60 million of debt. That is, the company obtained $20 million from shareholders and $40 million from debtholders to finance its operations. Its capital structure is, therefore, 25% (=$20million/ ($20 million+$60 million) ) equity and 75% (=$60million/ ($20 million+$60 million) ) debt. Please provide the solutions to the following questions (a, b) in the box below. If company issues $30 million new equity in order to retire some of its debt, what would be its new capital structure?
How do you think market would react on the announcement about the new equity issue? Why? Explain.