Kirk Limited, an automobile company financed by both debt and equity, is undertaking a new project. If the project is successful, the value of the firm in one year will be $100,000, but if the project is a failure, the firm will be worth only $20,000. The current value of Kirk is $50,000, a figure that includes the prospects for the new project. Kirk has outstanding zero coupon bonds due in one year with a face value of $40,000. Treasury bills that mature in one year yield a 5 percent Effective Annual Rate (EAR). Kirk pays no dividends. (Please note that no marks will be awarded if there are no workings provided in your answer.)

Required:

1. Use risk-neutral valuation approach to find the current value of Kirk Limited's debt and equity: what is the risk-neutral probability of the up state (i.e., the risk-neutral probability of an increase in the asset value)? What is the value of Kirk Limiteds equity? What is the value of Kirk Limiteds debt? (3 marks)
2. What is the current value of riskless debt with the same face value and maturity as Kirk Limiteds debt? (1 mark)
3. If Kirk Limited seeks a loan guarantee from its parent firm (Kirk Group holding), how much does this loan guarantee cost the parent firm? (1 mark)