Suppose company XYZ will be worth either 170 M or 120 M depending on whether the economy is strong (with 60% probability) or weak (with 40% probability) in one year, t=1. The current risk-free rate is 5% and the cost of equity if the company is 100% equity financed is 15%. Assume perfect world.

(4 points) What is the maximum amount XYZ can borrow (at t=0) under 5% interest rate? Calculate and explain briefly.

(4 points) What would be the companys debt-to-value ratio if XYZ borrows the amount you found in a)?

(10 points) Determine interest rate (cost of debt) at which XYZ could borrow $120 M.

(6 points) On the debt-to-value-ratio (as X) and Expected rate of return (as Y) plane draw graphs of rwacc, rE, and rd. Be specific. On the graph please indicate all the known values of rwacc, rE, and rd , indicate D/V value after which rd starts to increase.