Figure 111: Selected Information for Silicon Solutions Inc -Use the Information for Silicon Solutions Found in Figure 11

Figure 11.1: Selected information for Silicon Solutions Inc.
$\begin{array}{|l|l|l} \hline& \text { ALL EQUITY } & \text { EQUTTY AND DEBT } \\ \hline & & \\\hline \text { Number of shares } & 1,000,000 & 750,000 \\\hline \text { Price per share } & \$ 10 & \$ 10 \\\hline \text { Market value of shares } & \$ 10,000,000 & \$ 7,500,000 \\\hline \text { Market value of debt } & - & \$ 2,500,000 \\\hline & & \\\hline \text { Anticipated operating income } & \$ 1,000,000 & \$ 1,000,000 \\\hline \text { Interest } & - & \$ 150,000 \\\hline \text { Earnings (after interest) } & \$ 1,000,000 & \$ 850,000 \\\hline \text { Earnings per share } & \$ 1.00 & \$ 1.13 \\\hline \text { Return on shares } & & \\\text { Average cost of capital } & & \\\text { Return on debt } & & \\\hline\end{array}$
-Use the information for Silicon Solutions found in Figure 11.1 and assume perfect capital markets (PCM)to determine the average cost of capital for the unlevered firm.Then determine the return on shares,the return on debt,and the average cost of capital for the levered firm.What do you think will happen to the return on equity,return on debt,and the average cost of capital for the levered firm if the ratio of debt to equity is increased?
Silicon Solutions pays all of its operating income to shareholders as a dividend,which represents the return to the shareholders.Estimates for the firm's operating income next year,and in all subsequent years,is anticipated to be $1.0 million.Note that this is not a guaranteed amount,but simply the best guess of what the operating income will be.Because the firm does not expect the operating income to grow,and because all operating income is paid in dividends,the return to all shareholders will be the dividend yield they receive: $1.0 million relative to the $10 million market value of equity.