Question 5: (20 points) A. Discuss the static trade-off theory and the pecking order theory of capital structure. What a

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Question 5: (20 points)
A. Discuss the static trade-off theory and the pecking order
theory of capital structure. What are the main differences between
these two theories? (10 points)
B. Global Production (GP) is a large conglomerate thinking of
entering the smart alarm business, where it plans to finance a
project with a debt-to-value ratio of 20 percent. GP expects to
borrow for its smart alarm venture at an interest rate of 10%.
There is currently one firm in the smart alarm industry, American
Smart Alarm (ASA). This ASA firm is financed with 25 percent debt
and 75 percent equity. The beta of ASA’s equity is 1+(0.1x1 ) (.
ASA has a borrowing interest rate of 9%. The corporate tax rate for
both firms is 26%+(1%xA) (with A defined above). The market risk
premium is 8%, and the risk-free rate is 5%. What is the
appropriate discount rate (RWACC) for GP to use for its smart alarm
venture? (10 points