Your best friend is in a senior position of the finance department of Teenie Tiny and you are having lunch together after a round at the golf course. The discussion gets around to the fact that Teenie Tiny will lose their tax-exempt status and your friend mentions that all the debt that the company needs will be financed using bonds with a 5 percent coupon. However, you remember that during a lecture at SMU, it was mentioned that as a company issues more and more debt, the risk for the bondholders will increase and bondholders will require coupon interest rates to increase as the amount of debt increases. You have prepared the following table to assist in answering these questions:

Value of Debt	RD	Beta
EBIT	800,000	0	5.0%	1.392500
Tax Rate	40%	250,000	5.5%	1.483015
T-bill Rate	3.0%	500,000	6.0%	1.542274
TSX	11.0%	750,000	6.5%	1.607016
1,000,000	7.0%	1.678038
1,250,000	9.0%	1.756303
1,500,000	11.0%	1.842075
1,750,000	13.0%	1.939488
2,000,000	15.0%	2.047619

1. 
   
2. Calculate the required rate of return for the un-levered firm.
3. Calculate the market value of the un-levered firm in proposition I. 
4. Calculate the WACC for an un-levered firm in proposition II. 

4. Using the information from the table, calculate the value of the firm (proposition I), cost of equity, and the WACC (proposition II) each level of debt. 

Value of Debt	rD	Beta
0	5.0%	1.392500
250,000	5.5%	1.483015
500,000	6.0%	1.542274
750,000	6.5%	1.607016
1,000,000	7.0%	1.678038
1,250,000	9.0%	1.756303
1,500,000	11.0%	1.842075
1,750,000	13.0%	1.939488
2,000,000	15.0%	2.047619

5. 
   
6. Calculate the present value of distress.

Value of Debt	Value of the Firm World III	Value of the Firm World II	PV of Distress World III – World II
0
250,000
500,000
750,000
1,000,000
1,250,000
1,500,000
1,750,000
2,000,000

6. 
   
7. Graph (on 2 separate graphs) the information for proposition I and proposition II.
8. Briefly explain the amount of debt the company should use as a levered company.

To maximize the value of the firm and to minimize the WACC for the firm, the unlevered firm should issue $1,000,000 of debt.