Question: Stratford Corp. (SC) is considering a new project. SC estimates that there is a 25% probability that cash flows in one year will be $250,000,

Stratford Corp. (SC) is considering a new project. SC estimates that there is a 25% probability that cash flows in one year will be $250,000, and a 75% probability the cash flows will be $350,000. The cost of the project is $200,000. The project's cost of capital is 15% and the risk-free rate is 5%.

If the project is financed with 50% debt (at the risk-free rate), what should the value of the equity be? What is the expected return on the levered equity?

If the company finances the project with 30% debt (at the risk-free rate), what should the value of the equity be? What is the expected return on the levered equity?

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