Assume the market value of Tony Inc' equity, preferred stock and debt are $7 billion, $4 billion and $10 billion respectively. The firm has a beta of 1.4, the market risk premium is 6% and the risk-free rate of interest is 4%. The firm's preferred stock pays a dividend of $3 each year and trades at a price of $25 per share. The 10% coupon bond issued by the firm trades with a yield to maturity of 8.5%. The firm's tax rate is 35%.

Required:

a) What is the firms cost of equity? [1 mark]

b) What is the firms weighted average cost of capital? [3 marks]

c) What is the assumption about leverage when using the WACC to evaluate a project? [2 marks]

d) How does the interest paid by a firm affect its value to investors? [2 marks]