13. Answer ALL parts a) Consider Wotsit PLC, a UK company with an equity cost of capital of 15% and a debt cost of capital of 10%. The company has a debt to equity ratio of one (D/E = 1).

i. Suppose the company operates in a world without taxes. Find the weighted average cost of capital of this company (assuming no tax). (5 marks)

ii. Now suppose that the company has to pay corporation tax at a rate of 30%, and find the after-tax WACC of this company. Compare and contrast your result in this part with that of part (i), and briefly explain any difference. (5 marks)

iii. Explain which of the two results in parts (i) and (ii) is the appropriate cost of capital to use if you are evaluating an all-equity financed project with the same risk as Wotsit PLC. (5 marks)

b) Consider the U.S. company Teatree Inc. Its current stock price is $25. In the next year, this stock will either go up to $40 or down to $10. The stock pays no dividends. The one-year risk-free interest rate is expected to remain constant at 5%. Using the replicating-portfolio approach in the binomial option pricing model, calculate the price of a one-year call option on the companys stock with a strike price of $20. (10 marks)

c) Explain how and why the equity and debt of a levered company with limited liability can be modeled and valued as options. For these options, what are the underlying asset(s), maturities, strike prices and payoffs at maturity to the option holders? Draw a diagram to illustrate your answer. (10 marks)

Please use excel. Disclosure: this is NOT homework that I intend to submit.