The UK-based company XYZ has just made a 1.2m investment. The company is a start-up company with no other assets. The data for the investment and financing of the project are given in the table below. Use this information to answer the questions. You should also assume that Modigliani-Miller irrelevance of borrowing decisions holds.

	Duration of the project	10 years
	Scrap value of equipment at the end of the project	300,000
	Annual Sales	500,000
	Annual costs (variable)	100,000
	Annual costs (fixed)	100,000
	Working capital	10% of next years sales
	Risk free interest rate	3%
	Average return on the market portfolio	8%
	Beta of the project	0.7
	Tax rate (corporate and personal)	0
	Outstanding debt	500,000 (face value)
	Coupon rate of debt	5%
	Yield to maturity of debt	5%

a) What is the weighted average cost of capital for the firm?

b) What are the returns of the firms debt and equity?

3. Since making the investment the firm has decided to issue 100,000 more worth of equity that is used to lighten the debt burden. The yield-to-maturity of the debt remaining is still 5%. What are the returns of the firms debt and equity after the recapitalization?

4. Explain how the Modigliani-Miller irrelevance of borrowing decisions theorem arises (there is no need to use algebra just explain your answer in plain English). Explain how irrelevance would break down if we introduced corporate taxes and bankruptcy costs.