Suppose company ABC will be worth either 180 M or 100 M depending on whether the economy is strong or weak in one year. Both states of the economy are equally likely. The current risk-free rate is 5% and the cost of equity if the company is 100% equity financed is 12%. Assume perfect world.

1. What is the current value of ABC if it is all-equity financed?

2. What is the (before-tax) cost of debt, r_d, if ABC borrows $80 M? Explain (be brief).

3. What is the (before tax) cost of debt if ABC borrows $ 99 M? Hint: determine whether the debt is risky or not. If yes, recall how to estimate cost of risky debt.

4. What is the cost of equity if ABC borrows $ 99 M? If you have not completed part c) you may assume that r_d = 7%.