Levered and unlevered equity.

Levered and unlevered equity. Assume there is a firm whose assets are expected to have a value of $1000 million at t=1 if the economy is good, or a value of $500 million at t=1 if the economy is a 1 bad. Assume the risk-free interest rate is 2%. Unlevered equity investment in the firm’s assets have a risk premium of 8%.

1.2.a(5 marks) What is the cost of capital for unlevered equity of the firm?

1.2.b(5 marks) What is the value of unlevered equity for the firm at t=0?

1.2.c(5 marks) If the firm chooses to borrow $200 million by issuing bonds, what would be the return of the bonds for investors, assuming perfect capital market?

1.2.d(5 marks) What is the return of the levered equity given the situation in part 1.2.c?

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