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Big Star Corp. is planning to start a new project. Next year, the project can...

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Finance

Big Star Corp. is planning to start a new project. Next year, the project can generate profits of either $220,000, $100,000, or $40,000, with all three scenarios equally likely. The project requires an initial investment of $80,000. The companys beta is 1.2, its cost of capital is 10%, and the riskfree rate is 4%.

C. Suppose the initial $80,000 is raised by borrowing at the risk-free interest rate instead of issuing equity. What are the cash flows of the levered equity, and what is its initial value according to Modigliani and Millers Propositions? Is the companys cost of equity the same as before? Explain your reasoning. [25 marks]

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