Question

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 the funds for the initial investment, you can both raise some amount of levered equity and borrow $80 at the risk free interest rate. For the net present value (NPV) of the project and the market value of the levered equity, which of the following statements is correct?

	A.	The NPV is $22.27 and the market value of the levered equity is $22.27
	B.	The NPV is $29.55 and the market value of the levered equity is $102.27
	C.	The NPV is $29.55 and the market value of the levered equity is $22.27
	D.	The NPV is $22.27 and the market value of the levered equity is $102.27

Answer 1

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