LP Bean Company, an all equity company, has an EBIT of $1,200,000 that it expects it will earn forever, and it pays all of its earnings as dividends to shareholders (i.e., no growth). The firm has a corporate tax rate of 45% and has an un-levered beta of 1.25. In the market, you observe that Government T-bills are being sold to yield 3% and the market risk premium is 6%. Assume a world of taxes and a cost for the risk of default.

a. What is the value of the firm if the firm issues $2,000,000 of bonds at par with a coupon rate of 7%? The beta for the equity of the leveraged firm is 1.95.

b. What is the optimal level of debt, $600,000 or $700,000? Explain.

c.What is the WACC for the firm at the optimal level of debt?

d. What are the financial distress costs when the firm as $2,000,000 in debt?