Question

Consider a project with free cash flow in one year of $140,738 or $162,796​, with either...

Consider a project with free cash flow in one year of

$140,738

or

$162,796​,

with either outcome being equally likely. The initial investment required for the project is

$80,000​,

and the​ project's cost of capital is

18%.

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

$80,000

is instead raised by borrowing at the​ risk-free interest rate. What are the cash flows of the levered​ equity, and what is its initial value according to​ M&M?

a. What is the NPV of this​ project?

The NPV is

​$48616.10

​(Round to the nearest​ dollar.)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?  The initial market value of the unlevered equity is

​$128616.10

​(Round to the nearest​ dollar.)c. Suppose the initial

$80,000

is instead raised by borrowing at the​ risk-free interest rate. What are the cash flows of the levered​ equity, and what is its initial value according to​ M&M?

The cash flows of the levered equity and the initial market value of the levered equity according to​ M&M is:  ​(Round to the nearest​ dollar.)

Date 0

Date 1

Initial Value

Cash Flow Strong Economy

Cash Flow Weak Economy

Debt

$80,000

​$

​$

Levered Equity

​$

​$

​$

Fill in the table

Homework Answers

Answer #1

Solution:

Cash flow = ?

Required rate of return=18%

Risk free interest rate=11%

N=TIME period

Initial investment=$80000

ExPECTED cash flow of project in one year =1/2(cash flow strong economy+weak economy)

=1/2(140738+162796)

=1/2*303534

=$151767

A)Present value=cash flow/(1+r)n-Initial investment

=151767/(1+0.18)-80000

=128616.10-80000

=$48616.10

B)Initial market value of the unlevered equity=pre tax earning(1-tax rate)/required rate of return

=151767(1-0)/1.18

=151767/1.18=$128616.10

C)

IN $ DATE0 DATE1
INITIAL VALUE INTEREST

CASH FLOW

STRONG ECONOMY

CASH FLOW

WEAK ECONOMY

DEBT 80000

88000*11%

=8800

88800 88800
LEVERAGED EQUITY 48616.10

48616*18%

=8750.8

73996 51938

cash flow available to debt holder=80000(1.11)=88800

cash flow available to equity=140738-88800=51938

=162796-88800=73996

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Consider a project with free cash flows in one year of ​$141,442 or ​$179,644​, with each...
Consider a project with free cash flows in one year of ​$141,442 or ​$179,644​, with each outcome being equally likely. The initial investment required for the project is ​$98,006​, and the​ project's cost of capital is 17 %. The​ risk-free interest rate is 12 %. 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...
1. Consider a project with free cash flows in one year of $132,824 in a weak...
1. Consider a project with free cash flows in one year of $132,824 in a weak market or $171,945 in a strong​ market, with each outcome being equally likely. The initial investment required for the project is $90,000​, and the​ project's unlevered cost of capital is 10%. The​ risk-free interest rate is 12%. (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...
Consider a project with free cash flows in one year of ​$142,000 or ​$180,000​, with each...
Consider a project with free cash flows in one year of ​$142,000 or ​$180,000​, with each outcome being equally likely. The initial investment required for the project is ​$90,700​, and the​ project's cost of capital is 17%.  The​ risk-free interest rate is 10%.                              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...
Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a project and...
Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a project and how to finance it. The project has free cash flows in one year (year 1) of $90 in a weak economy or $120 in a strong economy. There is 75% chance that the economy is strong. The initial investment required for the project is $80, and the project's cost of capital is 10%. The risk free interest rate is 5%. Suppose that to raise...
Consider a project with free cash flows in one year of $90,000 in a weak economy...
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 12%. The risk-free interest rate is 3%. Suppose that you borrow only $50,000 in financing the project. According to MM, the firm's equity cost of capital will be closest to:
Consider a project with free cash flows in one year is $90,000 in a weak economy...
Consider a project with free cash flows in one year is $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.   Suppose that you borrow $60,000 in financing the project. According to the MM proposition II, the firm's equity cost of capital will be closest to: a. 45% b. 30%...
Consider a project with free cash flows in one year of $90,000 in a weak economy...
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. Suppose that you borrow only $40,000 at risk free rate and issues new equity to cover the remainder the firm's equity cost of capital will be closest to? (Please...
Consider a project with free cash flows in one year of $90,000 in a weak economy...
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. Suppose that you borrow only $45,000 in financing the project. According to MM proposition II, what is the firm's equity cost of capital? (PLEASE provide formulas, Step-by-step process for...
Suppose Uber has only one project with a cash flow of $40,000 and an unlevered cost...
Suppose Uber has only one project with a cash flow of $40,000 and an unlevered cost of equity of 10%. If the company borrows $20,000 at 5% to make the investment, what is expected return to equity holders? The answer is 16.11%, but I am not sure how my prof got that answer.
Project Cash Flow Today (millions) Cash Flow in One Year (millions) A -$10 $20 B $6...
Project Cash Flow Today (millions) Cash Flow in One Year (millions) A -$10 $20 B $6 $4 C $18 -$12 Suppose all cash flows are certain and the​ risk-free interest rate is 5%. a. What is the NPV of each​ project? b. If the firm can choose only one of these​ projects, which should it​ choose? c. If the firm can choose any two of these​ projects, which should it​ choose?