DME Group is a premier global supplier of mould bases. It is an unlevered firm and it has constant expected operating earnings (EBIT) of $4 million per year. The firm's tax rate is 35 percent and its market value is $12 million. The management is considering the use of some debt financing. Its plan is that the issued debt would be used to buy back the stock, so that the size of the firm would remain the same. Since the interest expense is tax deductible, the value of the firm would tend to increase as debt is added to the capital structure, but there would be an offset in the form of a rising risk of financial distress. The firm's analysts have estimated, as an approximation, that the present value of any future financial distress costs is $6 million, and that the probability of distress would increase with leverage according to the following schedule: SI No Value of Debt Prob. of Distress $2,500,000 5000000 0 1 2 1.5 3 7500000 2.25 4 10000000 6.5 5 12500000 15000000 6 12.25 31.5 74.75 7 20000000 A. What is the firm's cost of equity and weighted average cost of capital (WACC) at this time? B. According to the "pure" MM with - tax model, what is the optimal level of debt? C. What is the optimal capital structure when financial distress costs are included? D. Plot the value of the firm, with and without distress costs, as function of the level of debt