Consider a project with free cash flows in one year of $136,659 in a weak market or $162,877 in a strong market, with e
Posted: Sat Nov 27, 2021 5:27 pm
Consider a project with free cash flows in one year of $136,659
in a weak market or $162,877 in a strong market, with each
outcome being equally likely. The initial investment required for
the project is $110,000, and the project's unlevered cost of
capital is 16%. The risk-free interest rate is 11%. (Assume
no taxes or distress costs.)
a. What is the NPV of this project?
b. Suppose that to raise the funds for the
initial investment, the project is sold to investors as
an all-equity firm. The equity holders will receive the cash
flows of the project in one year. How much money can be raised in
this way—that is, what is the initial market value of the
unlevered equity?
c. Suppose the initial $110,000 is instead raised by borrowing
at the risk-free interest rate. What are the cash flows of
the levered equity in a weak market and a strong market at the end
of year 1, and what is its initial market value of the
levered equity according to MM?Assume that
the risk-free rate remains at its current level and ignore
any arbitrage opportunity.
in a weak market or $162,877 in a strong market, with each
outcome being equally likely. The initial investment required for
the project is $110,000, and the project's unlevered cost of
capital is 16%. The risk-free interest rate is 11%. (Assume
no taxes or distress costs.)
a. What is the NPV of this project?
b. Suppose that to raise the funds for the
initial investment, the project is sold to investors as
an all-equity firm. The equity holders will receive the cash
flows of the project in one year. How much money can be raised in
this way—that is, what is the initial market value of the
unlevered equity?
c. Suppose the initial $110,000 is instead raised by borrowing
at the risk-free interest rate. What are the cash flows of
the levered equity in a weak market and a strong market at the end
of year 1, and what is its initial market value of the
levered equity according to MM?Assume that
the risk-free rate remains at its current level and ignore
any arbitrage opportunity.