Consider a company that needs to make an investment of $10,000. This investment can be financed with any combination of stocks and/or bonds. Assume that the interest rate on bonds is 7.5%. Also assume that in good years the company earns $1,400 and in bad years the company earns $400. Good years and bad years occur with equal probability.

a)Use this information to fill in the following table which summarizes the effects of different financing options for this firm

Allocation Interest Paid			Equity Payment ($) Expected			Expected Return(%)	Standard Deviation(%)
Stocks	Bonds	to Bonds	Bad Year	Good Year	Payment ($)
100%	0%
75%	25%
50%	50%

b)Why would this firm never choose a financing option that is 10% stocks and 90% bonds

c)Explain how bond financing creates leverage for equity financing ?

(d) Suppose this is a publicly traded company on the NYSE and is listed in the Dow Jones Industrial Average and has a current bond rating of AA through Moodys. Is the Dow Jones Industrial Average a price weighted or a value weighted index? Explain the main difference between the styles of weighting.

(e) Suppose Moodys is considering downgrading this companys bonds from AA to B. What information does the market learn about this company from the downgrade?

(f) Would this downgrade influence the 7.5% on this companys bonds? If so, would this company need to lower or raise the interest rate on their bonds? Why?

(g) Suppose the company did change their interest rate because of the downgrade. How would this influence the information in the above table? How would this change restrict the financing for the company?