Question

Acort Industries owns assets that will have a(n) 60% probability of having a market value of $49 million in one year. There is a 40% chance that the assets will be worth only $19 million. The current risk-free rate is 7%, and Acort's assets have a cost of capital of 14% a. If Acort is unlevered, what is the current market value of its equity? b. Suppose instead that Acort has debt with a face value of $17 million due in one year. According to MM, what is the value of Acort's equity in this case? c. What is the expected return of Acort's equity without leverage? What is the expected return of Acort's equity with leverage? d. What is the lowest possible realized return of Acort's equity with and without leverage ? a. If Acort is unlevered, what is the current market value of its equity? The current market value of the unlevered equity is $ million (Round to three decimal places.) b. Suppose instead that Acort has debt with a face value of $17 million due in one year. According to MM, what is the value of Acort's equity in this case? According to MM, the current market value of the levered equity is s million (Round to three decimal places.) c. What is the expected return of Acort's equity without leverage? What is the expected return of Acort's equity with leverage? The expected return of Acort's equity for both cases is: Without Leverage: With Leverage: Expected Return % (Round to two decimal places.) % (Round to two decimal places.) d. What is the lowest possible realized return of Acort's equity with and without leverage? The lowest possible realized return of Acort's equity in both cases will be Without Leverage: With Leverage: Realized Return % (Round to two decimal places.) % (Round to two decimal places.)

Answer 1

a,If Acort is unlevered, what is the current market value of its equity?

Value of unlevered equity = Value of unlevered firm / Discounted expected future value of the firm

(0.60*49+0.40*19)/1.14

37/1.14

32.45614035

Value of unlevered equity = 32.46 million

b.To calculate the value of debt note that we are told that the debt has a face value of $17 million in 1 year

To calculate its value today, we need to discount, using the appropriate discount rate which is therisk-free rate.

Value of debt =17 million/1.07

15.88785047

Since there is no cash, this is also the value of net debt.To calculate the value of levered equity, remember that Value of levered equity = Value of levered firm- value of net debt

32.46-15.88

16.56828988

Value of levered equity is 16.57 million

c.

With out leverage R=37/32.46-1

14%

With out leverage R=37-17/16.57-1

20.71%

D.

With out leverage R=17/32.46-1

-48%

With out leverage R=0/16.57-1

-100.00%