The common stock and debt of Northern Sludge are valued at $65 million
and $35 million, respectively. Investors currently require a 15.9%
return on the common stock and a 7.8% return on the debt. If Northern
Sludge issues an additional $14 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.
Required:
New return on equity
