Answer to Question #228172 in Financial Math for Adwoa

Question

A company needed ghc 1000 to finance its activities. The firm can financed this expenditure either by bonds or equity. Interest rate on bonds is 10%. The company can earn ghc 160 in good years and ghc80 in bad years. Assuming the firm faces equal probability of good and bad years;

i What will be the stream of returns on both bonds and equity if the company chooses the following financing options

a 100% equity financing b 50% equity financing c 20% equity financing d 0% equity financing

ii Estimate the equity risk associated with each option in (i)

iii As an investor who wants to purchase a share in the company, which financing option will make you purchase the stock. Why????