Consider a firm in a two-period setting (time and time 2) with the following distribution of values at time 2:

Suppose the corporate tax rate is 50%. If the firm becomes insolvent at time 2, the cost incurred would be $200, which is deducted from the firms value. Suppose further that time 0 prices of (unit) contingent claims for the two states of the world are each 0.45.

a. What is the firms weighted average cost of capital if the firms capital is 100% equity financed?

b. If there is $600 worth of debt-bearing interest rate of 10% in the firms capital, what is the firms weighted average cost of capital?

c. If there is $1000 worth of debt-bearing interest rate of 10% in the firms capital, what is the firms weighted average cost of capital?

State Probability Values (t=2) 0.5 0.5 $3,600 $1,600 State Probability Values (t=2) 0.5 0.5 $3,600 $1,600