Consider a company with the following information. The market value of the firm assets is $8,000, which in a year will either increase to 120% or decrease to 80% of the current market value. The risk free rate is 5%. Tax rate is 35%, and bankruptcy costs 60% of the asset value. The company is deciding on how much of (zero-coupon) debt to take in order to maximize total firm value. Three choices of debt face value are available: $3,000; $6,000; and $10,000.

1. Find firm value for each debt choice.

b) Plot these values with debt value as the x-axis and the value of the firm as the y-axis.

c) What is the optimal capital structure among the three choices?