1. Show your work. No credits will be given if only answers are shown.

A company has a zero coupon bond issue outstanding with a par (or face) value of $30 million that matures in 18 months. The current market value of the firm's assets is $35 million. The annualized standard deviation of the return on the firm's assets is 40 percent, and the annual risk-free rate is 5 percent, compounded continuously.

a. The firm has a new project available. The net present value of the project is $3 million. if the company undertakes the project, what is the market value of the firm's equity and debt based on the Black-Scholes model? Assume that volatility remains the same.

b. What is the firm's continuously compounded cost of debt after the project is undertaken?