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Question 3. (7 marks) Depending upon the success of a new product, a firm will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. Assume that the cash flows are unrelated to the state of the economy (i.e. risk is diversifiable) so that the beta is O and the cost of capital equals to the risk-free rate, which is currently 5% per year. Assuming that in the event of default, 20% of the value of the firm's assets will be lost as bankruptcy costs. The capital markets are otherwise perfect. . a. Calculate the initial value of the firm's equity without leverage. (2 marks) b. Suppose that the firm has zero-coupon debt with a $125 million face value due in one year. Calculate the total value of the firm and the present value of financial distress costs. (3 marks) c. In general, what is the implication of financial distress costs on firms' optimal C. capital structure? Discuss. (2 marks) Question 3. (7 marks) Depending upon the success of a new product, a firm will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. Assume that the cash flows are unrelated to the state of the economy (i.e. risk is diversifiable) so that the beta is O and the cost of capital equals to the risk-free rate, which is currently 5% per year. Assuming that in the event of default, 20% of the value of the firm's assets will be lost as bankruptcy costs. The capital markets are otherwise perfect. . a. Calculate the initial value of the firm's equity without leverage. (2 marks) b. Suppose that the firm has zero-coupon debt with a $125 million face value due in one year. Calculate the total value of the firm and the present value of financial distress costs. (3 marks) c. In general, what is the implication of financial distress costs on firms' optimal C. capital structure? Discuss. (2 marks)