Question

Kinetic Company is considering an investment project that generates a cash flow of $1,700,000 next year if the economy is favorable but generates only $780,000 if the economy is unfavorable. The probability of favorable economy is 55% and of unfavorable economy is 45%. The project will last only one year and be closed after that. The cost of investment is $1,250,000 and Kinetic Company plans to finance the project with $350,000 of equity and $900,000 of debt. Assuming the discount rates of both equity and debt are 0%. What is the expected cash flow to Kinetic Company s creditors if the company invests in the project?

1,250,000

900,000

780,000

846,000

0

Answer 1

Total Investment = 1,250,000

Debt out of this investment = 900,000

Expected cash flow from the project = 55% * 1,700,000 + 45%* 780,000 = 1,250,000

So first the debt holders are paid. As the interest rate is 0%, only the principal is repaid

So Answer is b) 900,000