Question

Sunshine Amusement Parks Corporation exists in a world where there are only two periods: t=0 when capital expenditures can be made, and t=1 when cash flows are realized in one of two states of the world. The two states of the world are sunny summer weather or rainy summer weather. The probability of a sunny summer is 65% and the probability of a rainy summer is 35%. Sunshine’s existing assets pay off $180M if the summer is sunny and $40M if the summer is rainy.

Sunshine is considering an investment in new rides that will pay off $60M in a sunny summer and $15M in a rainy summer. Sunshine executives are still calculating the CAPX required for the project, so that the NPV is still unknown. However, they do know the cost will not be more than $100M. All costs for the project will be paid for by issuing debt, whose face value will be denoted by F. All numers are in millions.

The risk-free rate is zero. Summer weather is uncorrelated with the stock market. There are no taxes, costs of financial distress, or asymmetric information between managers and investors.

If the firm had no debt outstanding before doing the project, what would be the maximum initial cost and minimum NPV at which shareholders will vote to undertake the project?

44.25

47.75

45.25

49.25

Answer 1

New Rides
	Payoffs	Probability	Pay * Probability
Shinning summer	60	65%	39.00
Rainy summer	15	35%	5.25
		Total	44.25
So option a is correct. Probable cash flow will be 44.25 which can be expensed and voted by shareholders as this will not impact the
earlier profitability of company