1. Assume that the firm’s optimal debt ratio is 40%. The following required rates of return are estimated based on this debt ratio:
Cost of debt: .05
Cost of equity: .12
If the tax rate is 40%, what is the firm's weighted average cost of capital, WACCcomp?
a. 8.4%
b. 9.2%
c. 8%
d. 8.8%
2. The firm has a debt obligation of 100 due at t=1. The current asset value is 97; that is, the firm is under financial distress. The management believes that the asset value is most likely to remain at 97 at t=1 and the firm would go under. The firm has an investment project at the present time that requires 10 as initial investment. The value of the project has a 90% chance to become 12 (that is, a gain of 2) and a 10% chance to become 9 (that is, a loss of 1). The WACC for the project is 10 percent. What is the expected cash flow at t=1 for debt-holders if the firm undertakes the project?
a. $100
b. $98.0
c. $99.3
d. $-4
e. $98.7