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Correct answer is 50%. Please explain how to solve.

5. A firm currently has the following balance sheet. Assets Debt Equity Bad state (50%) $50 $42 $8 Good state (50%) $170 $42 $128 Expected $110 $42 $68 PV $110 / 1.1 = $100 $42 / 1.05 = $40 $68 / 1.1333 = $60 The dollar amounts in the first three columns are time one cash flows. The last column shows the present values of these cash flows. A the firm is planning to switch to higher-risk / lower-valued assets in order to help its stockholders. The higher-risk / lower- valued assets pay $24 in the bad state and $174 in the good state. The lender will charge a higher promised interest rate to protect themselves against the possibility that the firm will risk-shift. What promised interest rate will the lender need to charge in this problem so that they still receive an expected return of 5% on their $40 loan? Hint: filling in the blanks in the following table will help you answer the question. Ignore taxes. + Bad state (50%) Good state (50%) Expected PV Assets $24 $174 $99 $99 / 1.1 = $90 Debt $42 / 1.05 = $40 Equity $57 / 1.14 = $50 O 5. A firm currently has the following balance sheet. Assets Debt Equity Bad state (50%) $50 $42 $8 Good state (50%) $170 $42 $128 Expected $110 $42 $68 PV $110 / 1.1 = $100 $42 / 1.05 = $40 $68 / 1.1333 = $60 The dollar amounts in the first three columns are time one cash flows. The last column shows the present values of these cash flows. A the firm is planning to switch to higher-risk / lower-valued assets in order to help its stockholders. The higher-risk / lower- valued assets pay $24 in the bad state and $174 in the good state. The lender will charge a higher promised interest rate to protect themselves against the possibility that the firm will risk-shift. What promised interest rate will the lender need to charge in this problem so that they still receive an expected return of 5% on their $40 loan? Hint: filling in the blanks in the following table will help you answer the question. Ignore taxes. + Bad state (50%) Good state (50%) Expected PV Assets $24 $174 $99 $99 / 1.1 = $90 Debt $42 / 1.05 = $40 Equity $57 / 1.14 = $50 O

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