The Rivoli Company has no debt outstanding, and its financial position is given by the following data:
| Assets (Market value = book value) | $3,000,000 |
| EBIT | $500,000 |
| Cost of equity, rs | 10% |
| Stock price, Po | $15 |
| Shares outstanding, no | 200,000 |
| Tax rate, T (federal-plus-state) | 40% |
The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 25% debt based on market values, its cost of equity, rs, will increase to 11% to reflect the increased risk. Bonds can be sold at a cost, rd, of 9%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.
