Question

10. Consider a firm whose only asset is a plot of vacant land, and whose only liability is debt of $15.1 million due in one year. If left vacant, the land will be worth $9.6 million in one year. Alternatively, the firm can develop the land at an upfront cost of $19.6 million. The developed the land will be worth $34.2 million in one year. Suppose the risk-free interest rate is 10.1%, all cash flows are risk-free, and there are no taxes. a. If the firm chooses not to develop the land, what is the value of the firm's equity today? What is the value of the debt today? b. What is the NPV of developing the land? c. Suppose the firm raises $19.6 million from the equity holders to develop the land. If the firm develops the land, what is the value of the firm's equity today? What is the value of the firm's debt today? d. Given your answer to part (c), would equity holders be willing to provide the $19.6 million needed to develop the land? a. If the firm chooses not to develop the land, the value of the equity is $ million. (Round to two decimal places.) If the firm chooses not to develop the land, the value of the debt is $ million. (Round to two decimal places.) b. The NPV of developing the land is $ million. (Round to two decimal places.) c. If the firm raises $19.6 million from the equity holders to develop the land, the value of equity is $ million. (Round to two decimal places.) If the firm raises $19.6 million from the equity holders to develop the land, the value of debt is $ million. (Round to two decimal places.) d. Given your answer to part (c), would equity holders be willing to provide the $19.6 million needed to develop the land? O A. Yes. Equity holders will be willing to accept the deal because for them it is a positive-NPV investment. O B. No. Equity holders will not be willing to accept the deal because for them it is a positive-NPV investment. O C. Yes. Equity holders will be willing to accept the deal because for them it is a negative-NPV investment. OD. No. Equity holders will not be willing to accept the deal because for them it is a negative-NPV investment.

Answer 1

We are going to answer a) If the firm doesn't develop, what is the value of the firm and what is the value of debt today?

Answer:

To find out the value of the firm today we should know the Value of asset and value of debt today.

Present Value of Asset today=Present Value of undeveloped land=9.6million * (1-0.101)=9.6 million*0.899=8.6304 million

Present value of debt today=15.1million*(1-0.101)=15.1 million*.899=13.5749 million

So value of the firm = 8.6304 million-13.5749 million = 4.9445 million negative