You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $24 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $2.4 million. Investors are willing to provide you with $2.4 million in initial capital in exchange for 50% of the unlevered equity in the firm.
a. What is the total market value of the firm without leverage?
b. Suppose you borrow $0.3 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $2.1 million you need?
c. What is the value of your share of the firm's equity in cases (a) and (b)?
a) Total Market value of the equity without leverage = Fund Raised / Share of Capital
Total Market value of the equity without leverage = $2.4 / 50%
Total Market value of the equity without leverage = $4.8 Million
b) Total value of firm is $4.8 million.
Equity Value After Debt = $4.8 Million - $0.03 Million = $4.5 Million
Fraction of equity = Amount to be raised / Current Equity
Fraction of equity = 2.10 / 4.5
Fraction of equity = 46.67%
c)
(a) Value of Share = Total value * 50% = $4.8 Million * 50% = $2.4 Million
(b) Value of Share = Total value * (1 - 46.67%) = $4.5 Million * 53.33% = $2.4 Million
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