Question

Consider a project with a free cash flows in one year of 149,546 or 179,003, with each of outcome being equally likely, the initial investment required for the project is 93,227 and the project's cost of capital is 17%, the risk-free interest rate is 7%. e funds f

A) What is the NVP 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 the initial market value of the unlevered equity,

C) Suppose the initial 93,227 is instead raised by borrowing at the risk-free interest rate. What are the cash flows of the levered equity, what is its initial value and what is the equity according to MM.

Debt Initial value cash flow Strong Economy

93,227 cash flow weak economy

levered equity

Answer 1

Cost of capital	17%
risk free rate	7%
Base case
Scenario		Worst care	Best case	Risk weighted
Probability		50%	50%	=(149546*0.5)+(179003*0.5)
Year	0	1	1	1
Cash flows	(93,227)	149,546	179,003	164,275
Present value	(93,227)	127,817	152,994	140,406
NPV		34,590	59,767	47,179

Value to the investor as an all-equity firm=

47,179

100% leverage
Scenario		Worst care	Best case	Risk weighted
Probability		50%	50%	=(149546*0.5)+(179003*0.5)
Year	0	1	1	1
Cash flows	(93,227)	149,546	179,003	164,275
Interest payment		(6,525.89)	(6,525.89)	(6,525.89)
Net cash flows	(93,227)	143,020	172,477	157,749
Present value	(93,227)	122,239	147,416	134,828
NPV		29,012	54,189	41,601

Value to the investor as an leveraged firm=

41,601