1.Consider a project with initial investment of $1,000,000, and the expected free cash flow of $95,000 a year in perpetuity. The opportunity cost of capital with all-equity financing is 10%, and the project allows the firm to borrow at 7%. The tax rate is 21%.

Use APV to calculate the project's value.

a. Assume first that the project will be partly financed with $400,000 of debt and that the debt amount is to be fixed and perpetual.

b. Then assume that the initial borrowing will be increased or reduced in proportion to changes in the market value of this project.

Explain the difference between your answers to (a) and (b).