## Question

###### The world is risk neutral and interest rates are 20%. With probability ¼, your firm will...

- The world is risk neutral and interest rates are 20%. With probability ¼, your firm will be worth $60 next year. With probability ¾, it will be worth $100. What interest rate do you have to promise to raise $70 in debt today?
- In a perfect world, if the firm value is $76 under the debt-laden capital structure (say $70+$6), but the managers chose the $75 capital structure (say, all equity), what would you do?
- How does the cost of capital of the firm depends on the firm’s leverage ratio?
- If the cost of capital of equity goes up and the cost of capital of debt goes up, and the firm consists only of debt and equity, does the capital of the firm goes up?

## Answers

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