Returning to the subject of the first question above, an employee of Grant Avenue Consolidated has resigned and is trying to raise money for a promising start-up. Depending on how well the new business does, it will have, in one year, an equal chance (25%) of being valued at either $8 million, $7.5 million, $5.5 million, or $4 million. The uncertainty about the outcome is diversifiable so no beta or other premium is required to discount it. The yield on a Treasury bond is 3%.

a. Compute the current value of the firm without any debt.

b. Suppose the firm instead has issued zero-coupon debt with a $6 million face value due next year. Estimate the current value of this debt.

c. Compute the yield and expected return on this debt.

d. Compute the value of the equity and the total value of the firm with this debt