Star, Inc., a prominent consumer products firm is a 100% equity firm. Currently, there are 2,000 shares outstanding and the price per share is $7. Its assets will be worth $21,500 in one year if the economy is strong, and $10,000 in one year if the economy is weak. Both events are equally likely. Assume the capital market is perfect and there are no taxes.

a. What is the current firm value of Star, Inc.?

b. What is the cost of equity for the firm? (hint: discounted future cash flows)

c. If Star decides to issue $10,000 debt at the risk-free rate and uses the proceeds from issuing debt to repurchase existing shares. (1) According to MM, what will be the market value of its equity after the transaction? (2) What is the debt to value ratio after the transaction?