Use the following information to answer both Problem 1 and Problem 2. Consider ABC corporation. ABCs yearly (operating) free cash flows are expected to equal 200, each year forever, i.e., cash flows are perpetual. The discount rate for these cash flflows is 20%; the risk-free interest rate is 4%

Now assume that markets are perfect except that firms must pay corporate taxes. The tax rate = 0.25.

a.Suppose that ABC is all equity financed. What is the value of ABC Corp.? What is the required return on ABCs equity?

b. Now, suppose that ABC decides to issue perpetual debt worth 400. The proceeds from the debt issue will be paid to ABCs shareholders. This debt issue is risk free. ABCs debt will consist of perpetual bonds which make an interest payment each year forever. ABCs free cash flows will not be affected by the debt issue. After the debt issue, what is the value of ABC Corp? What is the required return on ABCs equity?