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XYZ Ltd is currently all equity financed with a market value of $1 million. Its management is considering the issue of bonds with a face value of $500,000 (issued at face value). The new funds raised will be used to repurchase shares from existing shareholders.
a) Illustrate the effect of leverage in a world with no taxes by sketching the relationship between the cost of equity and leverage for the all equity situation and the proposed (50% debt, 50% equity) on a fully labeled graph.
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