1. Q Corporation and R Inc. are two companies with verysimilar characteristics. The only difference between the twocompanies is that Q Corp. is an unlevered firm, and R Inc. is alevered firm with debt of $5 million and cost of debt of 10%. Bothcompanies have earnings before interest and taxes (EBIT) of $2million and a marginal corporate tax rate of 40%. Q Corp. has acost of capital of 15%.                       (20 marks total)

a. What is Q’s firmvalue?                                                                                   

b. What is R’s firmvalue?                                                                                    

c.   What is R’s equityvalue?                                                                       (1 mark)

d. What is Q’s cost of equitycapital?                                                      (1 mark)

e. What is R’s cost of equitycapital?                                                     .

f.   What is Q’sWACC?                                                                                   (1 mark)

g. What is R’sWACC?                                                                                

h. Compare the WACC of the two companies. What do youconclude?       (1 mark)

i.    What principle have you proven inthiscase?                                              (1 mark)

j.   Both companies are now evaluating aproject that requires an initial investment of $1.15 million andthat will yield cash inflows of $500,000 per year for the nextthree years. Assume that this project has the same risk level asthe individual firm’s assets. Should Q invest in this project?Should R invest in thisproject?                                                                                                                             

k. Based on your results for part (j), discuss theeffects of leverage and its tax shields effects on the future valueof the two firms.                               (1 mark)