. You are considering an investment opportunity that lasts for one year. The project will generate cash flows of either $2000 or $1000 next year, depending on whether the economy is strong or weak, respectively. Both scenarios are equally likely. The project cash flows depend on the overall economy and thus contain market risk. Market return is 15%, risk-free interest rate of 5%, and the unlevered beta is 1.5.

A) What is the expected return from the investment if you finance with all equity? What is the present value of this investment?

B) What is the standard deviation of the investment return?

Now suppose you decide to borrow $500 for this project. Since you are always able to repay the debt, you are able to borrow at the risk free rate.

C) What are the two possible cash flows you will receive after repaying the debt?

D) What is the expected return of the investment? What is the present value of this investment?

E) What is the standard deviation of the investment return?