Great Miners Inc. is currently an all-equity firm with 10,000 shares outstanding that have a share price of $50 each. Each year, there are two possible states of the economy: the firm's EBIT is either $20,000 or $35,000. The firm pays out all of its EBIT each year to shareholders.

(a) John owns 200 shares of the firm. What cash flows does he receive in a year where the economy is in each state of the economy?

(b) Suppose that the firm converts to a capital structure with a debt-value ratio of 40%. The firm can borrow at an interest rate of 5%. If John keeps all of his shares, what will his cash flow be in each state of the economy in a given year?

(c) Suppose that the firm does switch to the capital structure from part (b). Show how John could obtain the same cash flows in the two states of the economy that he had under the all-equity structure from part (a).

(d) What does your answer to part (c) imply about the firm's choice of capital structure?