Question

Consider a project with free cash flow in one year of $130,000 in a weak market or $180,000 in a strong market, with each outcome being equally likely. The initial investment required for the project is $100,000, and the project's unlevered cost of capital is 20%. The risk-free interest rate is 10%. (Assume no taxes or distress costs. a. What is the NPV 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 flow of the project in one year. How much money can be raised in this way—that is, what is the initial market value of the unlevered equity? c. Suppose the initial $100,000 is instead raised by borrowing at the risk-free interest rate. What are the cash flow of the levered equity in a weak market and a strong market at the end of year 1, and what is its initial market value of the levered equity according to MM? Assume that the risk-free rate remains at its current level and ignore any arbitrage opportunity a. What is the NPV of this project? The NPV is $ . (Round to the nearest dollar.) 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 flow of the project in one year. How much money can be raised in this way that is, what is the initial market value of the unlevered equity? The initial market value of the unlevered equity is $ (Round to the nearest dollar) c. Suppose the initial $100,000 is instead raised by borrowing at the risk-free interest rate. What are the cash flow of the levered equity in a weak market and a strong market at the end of year 1, and what is its initial market value of the levered equity according to MM? The cash flow of the levered equity in a weak market and a strong market at the end of year 1, and the initial market value of the levered equity according to MM is: (Round to the nearest dollar) Date 0 Initial Value $100,000 Date 1 Cash Flow Strong Economy Cash Flow Weak Economy Debt Levered Equity Enter your answer in each of the answer boxes.

Answer 1

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PV, FV, ANNUITY (Autosaved) Microsoft Excel (Product Activation Failed) Page Layout Formulas File Home Insert Data Review View Add-Ins E AutoSum - Cut AC Wrap Text Calibri 11 General Copy Fill Sort & Find & Filter Select Merge & Center Conditional Format Formatting as Table Styles Paste B I U 090 Cell Insert Delete Format % Format Painter Clear Clipboard Font Alignment Number Styles Cells Editing fox BV202 BW BU BV BX BY BZ CA CB CC CD CE CE CG CH 184 0.5*130000 0.5*180000 185 EXPECTED CASH FLOW AT THE END OF THE YEAR = 155000 186 NPV = PV OF CFAT - INVESTMENT NPV 155000 X PVIF @20%, 1 YEAR - 100000 187 155000/(1+0.2) - 100000 NPV= 188 29167 a 189 INITIAL MARKET VALUE OF EQUITY = CFAT FOR THE YEAR/ (1 COST OF EQUITY b 190 155000/1.2 = 191 INITIAL MARKET VALUE OF UNLEVRED EQUITY 129167 192 100000(1+0.10) 193 SUPPOSE FUNDS ARE RAISED BY ISSUING DEBT, AFTER A YEAR PAYMENT TO THEM 110000 C. 194 CASH FLOW AVAILABLE TO DEBT HOLDERS = 110000 SCENARIO1 195 OR 110000 SCENARIO2 196 |(130000 110000) 197 CASH FLOW AVAILABLE TO EQUITY = 20000 (180000- 110000) = 70000 198 OR 199 200 INITIAL VALUE ACCORDING TO MM = WILL NOT CHANGE 129167 LESS DEBT 201 100000 INITIAL EQUITY = 202 29167 LOAN OPTIONS pv, fv, annuity DOLLAR COST AVG profit margin loan with points EXPO ear FVA CAP STRU VALUE LOCK BOX DILUTION NPER APR CPI pva s2 s3 (-. erences 130% WA 07:24 ENG 31-10-2019

PV, FV, ANNUITY (Autosaved) Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins Σ AutoSum - Cut AC Wrap Text Calibri 11 General Copy Fill Merge & Center Conditional Format Formatting as Table Styles Paste B I U +.0 .00 .00 0 Cell Insert Delete Format Sort & Find & Filter Select % Format Painter Clear Number Editing Clipboard Font Alignment Styles Cells fox CB209 CH BY CC CD CE BU BV BW BX BZ CA CB CF CG 192 SUPPOSE FUNDS ARE RAISED BY ISSUING DEBT, AFTER A YEAR PAYMENT TO THEM 100000(1+0.10) 193 110000 C. 194 CASH FLOW AVAILABLE TO DEBT HOLDERS = 110000 SCENARIO1 195 OR 110000 SCENARIO2 196 (130000 110000) = 197 CASH FLOW AVAILABLE TO EQUITY = 20000 (180000- 110000) = 198 OR 70000 199 200 INITIAL VALUE ACCORDING TO MM = WILL NOT CHANGE 129167 100000 201 LESS DEBT INITIAL EQUITY = 29167 202 203 204 DATE 0 205 DATE 1 206 INITIAL VALUE CASH FLOW STRONG ECONOMY CASH FLOW WEAK ECONOMY debt 207 100000 110000 110000 levered equity 208 29167 70000 20000 209 210 profit margin loan with points pv, fv, annuity LOCK BOX DILUTION ear FVA s3 LOAN OPTIONS CAP STRU VALUE DOLLAR COST AVG EXPO NPER APR CPI S2 pva Rea (-. erences 130% WA 07:25 ENG 31-10-2019