Mellors Managment has debt of $1.2 million due at year end (P&I). The company's expected cash flow (no taxes) are $1 million with 40% probability and $2 million with 60% probability. Assuming the equity has an expected return of 25% and the firm is valued at $1.4 million;
1) What is the expected return on the firms debt?
2) How much does the firm's value decrease if bankruptcy costs $0.5 million?
3) What would be the expected return on equity in Mellors had no debt?