Suppose there is no corporate tax. The firm is the same firm in parts a) and b) of this problem. The firm's weighted average cost of capital is 15%.

a) (1 point) Suppose that the cost of equity is 25% and the interest rate the firm pays on its debt to investors is 10%. What is the proportion of the firm financed by equity?

b) (1 point) Suppose that the firm has 2 projects which result in identical cash flows over time. Project 1 is financed fully by equity while Project 2 is financed by 50% debt and 50% equity. Assuming that both have positive NPV:s and the firm can only invest into one of the projects, will firm invest into Project 1 or Project 2? An explanation is required to receive any points.

Answer rating: 100% (QA)

a To find the proportion of the firm financed by equity E we can use the formula for the weighted av... View the full answer