Question 1 (Without Taxes)

You are considering an investment opportunity.

- For an initial investment of $800 this year, the project will generate cash flows of either $1400 or $900 next year, depending on whether the economy is strong or weak, respectively. Both scenarios are equally likely

The project cash flows depend on the overall economy and thus contain market risk. As a result, you demand a 10% risk premium over the current risk-free interest rate of 5% to invest in this project.