5. Annuity versus perpetuity. You have just read an advertisement stating, ''Pay us $100 a year for the next ten years and we will pay you $100 a year thereafter in perpetuity." If this is a fair deal, what is the implied rate of interest?

6. Valuing a loan. A company borrowed $10 million for five years from Atlantic Bank. The company pays Atlantic Bank a fixed annual rate of 8 percent and must pay back the $10 million loan at the end of the borrowing period. A year has passed since the loan was made and Atlantic Bank wants to sell the loan to Pacific Bank.

a. If the interest rate is now 7 percent, what is the value of the loan?

b. What would be the value of the loan if the company was paying the bank 4 percent every six months instead of 8 percent per year?

8. Estimating a firm's cost of capital.

Shares of the Pacific Electric Corporation (PEC) have an estimated beta of 1.10.

PEC funds its assets with 50 percent debt at an average after-tax cost of debt of

6 percent. The excess return on the market portfolio is 5 percent and the risk-free

rate is 3 percent.

a. What is PEC's estimated cost of equity according to the CAPM?

b. What is PEC's estimated weighted average cost of capital?