You have identified two mutually exclusive investment opportunities. Both investments cost you $100. Investment A will turn into $130 in one year with a 50% chance and will shrink to $98 with a 50% chance. There is a 50% chance that Investment B will mature into $170 and a 50% chance that it will dwindle to $20. Assume zero discount rate.

(a) Calculate the NPVs and the expected ROE on the two investments. (8 marks) (b) Which investment would you prefer?

What if you have to borrow $10 at 10% to partially finance the investment? (c) Calculate the expected ROE of the two projects.

(d) Based on the results in (c), which investment would you choose?

What if the bulk of the $100 investment is financed by $80 debt? The interest cost will increase to 20% to reflect the adjusted risk.

(e) Calculate the expected ROE of the two projects.

(f) Based on the results in (e), which investment is better? Briefly explain why.

(g) Based on the results in (e), how large does the interest cost be charged to make the two investments indifferent?

(h) Do you believe adjusting the interest cost to the level in (g) can solve the problem? State your insight.