Both Firm A and Firm B have total assets with a market value of $108 million. For both firms, fixed assets account for 67.5% of the total assets, and cash available for investment accounts for the remaining 37.5%. The market value of the fixed assets is assumed to remain unchanged from year to year. Both firms have debt in their capital structure. The promised future value of the debt of Firm A, which is due in exactly a year, is $18 million. The rate of return on Firm As debt in both promised and the expected terms is 4.5%. All of Firm Bs debt is also due in exactly a year. Its promised future value is $225 million. The promised rate of interest on Firm Bs debt is 18%. Recall that the promised future value of debt equals the sum of the principal and interest

(a): Prepare the balance sheet for the two firms in terms of market value.

(b): Project X has a life of one year, and involves an outlay of $40.5 million. It will generate a cash inflow of $405 million in Event 1, which occurs with a probability of 0.1, and nothing otherwise. The cost of capital that takes the risk of the project into account is 45% per year. Project Y also has a life of one year, and also involves an outlay of $40.5 million. It will produce a cash inflow of $60 million next year with certainty. The risk free rate is 4.5%.

c) Indicate whether the following statements are true or false: (i): Project Y has a positive NPV so long as the risk free rate is less than 50%. (ii): Project X has a negative NPV so long as its cost of capital is positive