6.

a. Agency costs arise when there are conflicts of interest between stakeholders. A highly levered firm with risky debts faces agency costs. Provide discussions on one type of agency costs of leverage. (1.5 marks] b. Parnassus Corporation's Market Value Balance Sheet ($ Million) and Cost of Capital Assets Liabilities Cost of Capital Cash 250 Debt 450 Debt 6% Other Assets 1000 Equity 800 Equity 12% Tax rate 30% Parnassus Corporation's New Project Free Cash Flows ($ Million) Year 0 1 2 3 4 Free Cash Flow -150 60 90 120 144 Assume that this new project is of average risk for Parnassus Corporation and that the firm wants to hold constant its debt to equity ratio. Calculate the debt capacity for Parnassus Corporation's new project in year 1. [3.5 marks] NOTE: Typing is required. File attachment is NOT allowed