The outcome can be either good or bad. The probability that the good outcome realizes is 50%. The cash flow is shown in the above table. Given the riskiness of the business, investors require a 15% risk premium over the risk-free rate of 5%. To answer this, make appropriate assumptions. In answering the following questions, show detailed steps and discuss your results.

Q4. Suppose that you are an entrepreneur with the following business opportunity Year 0 Year 1 Cash flow Investment Good Bad Cash flow 500 1000 800 The outcome can be either good or bad. The probability that the good outcome realizes is 50%. The cash flow is shown in the above table. Given the riskiness of the business, investors require a 15% risk premium over the risk-free rate of 5%. To answer this, make appropriate assumptions. In answering the following questions, show detailed steps and discuss your results (a) What is the value of the unlevered equity in this business? What is the entrepreneurial profit? [25 marks] (b) What is the value of levered equity when debt is 100? What is the cost of levered equity in this case? [25 marks) (c) Using the above example, discuss and explain how an Increase in leverage increases the risk to the shareholders. Explain how it affects the share price. [50 marks] [Turn over] Page 3 of 4