Problem:
The common stock and debt of Northern Sludge are valued at $60 million and $40 million, respectively. Investors currently require a 16.7% return on the common stock and a 7.0% return on the debt.
Required:
Question 1: If Northern Sludge issues an additional $18 million of common stock and uses this money to retire debt, what happens to the expected return on the stock?
Question 2: Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes.
Note: Please describe comprehensively and provide step by step solution.