You expect your firm to be worth $50, $100, or $120 with probabilities 1/10, 6/10 and 3/10, respectively. You can raise $75 in debt proceeds today if you promise an interest rate of 10%. If this is how you finance your firm, then your cost of equity capital is 20%
What would be the debt-to-capital ratio of this firm (in the $50-debt financing scenario)?
What would be the cost-of-equity-capital for this firm (in the $50-debt financing scenario)?
Is the $75 debt-financing scenario cost-of-debt capital higher, or is the $50 debt-financing scenario cost-of debt capital higher? What does this mean for the relative risk of the two types of debt?
Is the $75 debt-financing scenario cost-of-equity capital higher, or is the $50 debt-financing scenario cost of-equity capital higher? What does this mean for the relative risk of the two types of equity?
Is the $75 debt-financing scenario cost-of-firm capital higher, or is the $50 debt-financing scenario cost-of- firm capital higher?