You are considering buying the bonds of a very risky company. A bond with a $100 face value, a 1-

year maturity, and a coupon rate of 22% is selling for $95. You consider the probability that the company will survive to pay off the bond by 80%. With 20% probability, you think that the company will default, in which case you think that you will be able to recover $40.

a. What is the expected return on the bond?

b. If the company has cost of equity rE = 25%, tax rate TC = 35%, and 40% of its capital structure is equity, what is its weighted average cost of capital?