4. a) Aloyol Inc., is an unlevered firm, and it has constant expected operating earnings (EBIT) of $2 million per year. Aloyol's tax rate is 40%, and its market value is V=S= $12 million. Management is considering the use of debt. (Debt would be issued and used to buy back stock, so the size of the firm would remain constant.) The firm's analyst have estimated, as an approximation, that the present value of any future bankruptcy cost is $8 million, and that the probability of bankruptcy would increase with leverage according to the following schedule: Value of Debt Probability of failure $ 2,500,000 0.00% 10,000,000 6.25 12,500,000 12.50 15,000,000 20,000,000 31.25 75.00 i. ii. What is Aloyol's cost of equity and average cost of capital at this time? According to the MM after-tax valuation model, what is the optimal level of debt? iii. What is the optimal capital structure when bankruptcy costs are included?