Compare the current value of Armin Industries with and without leverage, given the data in Table. Assume that the risk-free rate is 5%, the new product is equally likely to succeed or fail, and the risk is diversifiable.

ii) Extending  assume now that the costs of financial distress are $15 million. 

 

Compute the value of Moon's securities at the beginning of the year with and without leverage given that financial distress is costly.

 

iii) Honeywell International Inc. (HON) has a market debt−equity ratio of 0.5. - Assume its current debt cost of capital is 6.5%, and its equity cost of capital is 14%. - If HON issues equity and uses the proceeds to repay its debt and reduce its debt−equity ratio to 0.4, it will lower its debt cost of capital to 5.75%. - With perfect capital markets, what effect will this transaction have on HON's equity cost of capital and WACC? 

Value of Debt and Equity with and without Leverage ($ million) Without Leverage With Leverage Debt value Equity value Total to all investors Success $250 $250 Failure $90 $90 Success $150 $100 $250 Failure $75 $0 $75