QUESTION $2$

a$)$ Imagine a world with perfect certainty, no costs of financial distress and where the corporate tax rate is $20\%.$ Epsilon LTD has annual earnings before interest and taxes $($EBIT$)$ of $1,000.$ Interest rates on its debt are $5\%$ and will be so forever. How much debt and equity $($in $)$ should it have if it wanted to achieve its optimal capital structure?

$(4$ Marks$)$

b$)$ Now imagine another firm in the same world, Theta LTD$,$ where EBIT are also $1,000$ at date $1($and nothing at date $0$; today$)$ but are growing at $2$ percent per year so EBIT will be $1,020$ at date $2$ and so on$.$ How much debt and equity $($in $)$ should it have today if it wanted to achieve its optimal capital structure? $(6$ Marks$)$