Question 5 ( Assume a world with no taxes. You are offered an equity investment in two office buildings. Following is the financial information for these investments. You also know that for both investments the unlevered cost of equity () is 10%, and that the cost of debt () is 4%: Investment A Investment B Initial Investment $1,000,000 $800,000 Perpetual annual cash flow $120,000 $200,000 Perpetual annual return (= ) 12% 25% Debt-to-value 25% 75% Equity-to-value 75% 25% a. Calculate the cost of levered equity () for each investment. b. Given the initial investment amounts and the perpetual returns, which investment will you choose?

Question 6 Ross and Rachel are the equity holders of the all-equity financed company Friends Ltd. (Friends Ltd.). Each one of them holds 50% of Friends Ltd.s shares, and the overall number of outstanding shares of Friends Ltd. is 1,000. Ross and Rachel decided to go on a brake. Following this decision, it was agreed that Friends Ltd. will issue debt and with the proceeds will repurchase some of Rosss shares. Friends Ltd.s annual perpetual EBIT is $2,000. The HIMYM Ltd. company (HIMYM) is also an all-equity financed company, that operates in same field as Friends Ltd. HIMYM has an annual perpetual EBIT of $1,000, and its equity value is $7,000. The corporate tax rate is 30%. a. What is the unlevered value () of Friends Ltd.? b. What is the price per one share of Friends Ltd. before the debt issuance?

Assume that Friends Ltd. is issuing a perpetual debt of $7,000. These funds will be used to repurchase some of Rosss shares. How many shares will the company buy from Ross?

Question 7 (14 points) A company is considering an investment in a new project. The required investment in the project is $9,200, and the project is expected to produce a perpetual EBIT (that is, pre-tax operating profit) of $1,429 at the end of each year. The risk free rate () is 3%, the expected return of the market portfolio (()) is 10%, and the corporate tax rate is 30%. Assume no bankruptcy costs. The unlevered beta of the project () is 1.4, and the beta of the companys assets is 0.8. a. Assume the company plans to finance the project entirely by equity. Should the company invest in this project? Explain b. Assume the company can finance this investment with a $4,000 perpetual debt (and the rest with equity). The company approached the bank, and the bank said that the company can borrow this amount at 6% interest rate. Should the company take the loan and invest in the project? c. Following section (b), assume now that the bank reassessed the companys debt risk. Following this reassessment, the bank is willing to lend the company this amount at an interest rate of 4% (cost of debt is 4%). Assuming that the cost of debt is reduced to 4%, should the company invest in the project?