Question

The entrepreneur uses debt in the investment project. investment project. The value of debt today is 375$ and the interest on the debt over the next year is 5%. The initial value of levered equity is 835$. The value of the levered equity is 1544.75$ in the good state and 542.75$ in the bad state. The probability of being in the good state is 40%. Assume perfect capital markets. 1) What is expected return on levered equity and debt? 2) You prefer to hold unlettered equity. Explain how to replicate the payoffs of unlettered equity today and one year from today, and find the expected return on unlettered equity. 3) Explain without further calculations, what will happen to the debt cost of capital as debt increases to D=1000.

Answer #1

You are recruited by the founder of a start-up company to advise
her on the optimal capital structure for her company. The sole
project of the company will require an initial outlay (at date 0)
of £150,000, and is expected to generate a single cash flow in one
year (at date 1). The project cash flow at date 1 will take one of
two equally likely values depending on the state of the economy: if
the economy is strong, then...

You are considering raising dollars to invest in a project that
requires an investment today of $1,000; it is a one-period project
with an IRR of 15%. You will raise the dollars using a 25% debt to
total assets capital structure. Debt dollars will cost 5% before
tax, and equity dollars will cost 15%. Your tax rate is 30%.
1. Is the project acceptable?
2. What rate of return for the equity investors if project is
accepted? Show solution of...

A company has a market value of equity of $252,710, and a market
value of debt of $206,740. The company's levered cash flow (i.e.
cash flow after paying all interest) is $37,045 and is distributed
annually as dividends in full. The interest rate on the debt is
6.82%. You own $32,730 worth of the market value of the company's
equity. Assuming that the levered cash flow is constant in
perpetuity and there are no taxes, what is your annual expected...

8. An all-equity firm is considering financing its next
investment project with a combination of equity and debt. The asset
beta for the firm as a whole is 1.2 (recall that this is the same
as the equity beta for an all-equity firm, but not the same as the
equity beta for a “levered” firm). Assume the average rate of
return on the market is 6% and the risk-free rate is 1%. The cost
of debt for the company is...

Value Tree has suffered a series of negative shocks and is now
facing the following situation:
(1) It has debt outstanding of par value $40 million which is
due next year.
(2) Next year, its assets have the following prospects:
Probability
Asset value ($ million)
Good scenario
0.5
100
Bad scenario
0.5
10
The 1-year risk-free interest rate is now at zero.
(a) Determine the payoff to debt and equity holders next year in
the two scenarios. What is the...

The firm Lando expects cash flows in one year’s time of $90
million if the economy is
in a good state or $40 million if it is in a bad state. Both
states are equally likely.
The firm also has debt with face value $65 million due in one
year.
Lando is considering a new project that would require an
investment of $30 million
today and would result in a cash flow in one year’s time of $47
million in...

You are thinking of buying Amazon (AMZN) stock today. The price
of each share is $200. You will hold the stock for 1 year, collect
whatever dividend is paid at the end of that year, and then sell
the stock. Here are the possible dividends and prices 1 year from
today:
State
Probability
Dividend
Price
Good
0.05
10
250
Moderate
0.6
10
210
Bad
0.3
10
190
Extremely bad
0.05
0
190
a) Find the return you will make in...

Value Tree has suffered a series of negative shocks and is now
facing the following situation:
(1) It has debt outstanding of par value $40 million which is
due next year.
(2) Next year, its assets have the following prospects:
Probability
Asset value ($ million)
Good scenario
0.5
100
Bad scenario
0.5
10
The 1-year risk-free interest rate is now at zero.
(a) Determine the payoff to debt and equity holders next year in
the two scenarios. What is the...

You are
considering a 10-year project:
An initial investment (today) in equipment of
$900,000 is required. There will be no salvage value for this
equipment after 10 years.
The equipment is depreciated using the
straight-line method, $90,000/year for 10 years.
Annual expected revenues are $700,000/year for 10
years (beginning 1 year from today). Annual expected
operating expenses are $250,000/year for 10 years
(beginning 1 year from today). This $250,000 does not include
depreciation.
The tax rate is 35%.
An investment...

The firm Lando expects cash flows in one year’s time of $90
million if the economy is in a good state or $40 million if it is
in a bad state. Both states are equally likely. The firm also has
debt with face value $65 million due in one year. Lando is
considering a new project that would require an investment of $30
million today and would result in a cash flow in one year’s time of
$47 million in...

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