Question

Debt policy

The common stock and debt of Northern Sludge are valued at $50 million and $30 million, respectively. Investors currently require a 16% return on the common stock andan 8% return on the debt. If Northern Sludge issues an additional $10 million of common stock and uses this money to retire debt, what happens to the expected returnon the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes.

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