a. Consider the following outcomes both for the following scenarios with and without leverage for Moon Industries' new venture. Assume Moon's new venture is equally likely to succeed or to fail. The risk-free rate is 4%. The venture has a beta of 0 and the cost of capital is equal to the risk-free rate. Compute the value of Moon's securities at the beginning of the year with and without leverage. Without Leverage With Leverage Failure Failure $90 Success Success $150 Debt value Equity value Total to all investors $250 $250 $90 $90 $100 $250 $90 b. Now assume that the costs of financial distress is $15 million. Compute the value of Moon's securities at the beginning of the year with and without leverage given that financial distress is costly. Without Leverage Failure With Leverage Failure $75 Success Success $150 Debt value $250 $250 Equity value $90 $100 $0 Total to all investors $90 $250 $75
a. Consider the following outcomes both for the following scenarios with and without leverage for Moon Industries' new venture. Assume Moon's new venture is equally likely to succeed or to fail. The risk-free rate is 4%. The venture has a beta of 0 and the cost of capital is equal to the risk-free rate. Compute the value of Moon's securities at the beginning of the year with and without leverage. Without Leverage With Leverage Failure Failure $90 Success Success $150 Debt value Equity value Total to all investors $250 $250 $90 $90 $100 $250 $90 b. Now assume that the costs of financial distress is $15 million. Compute the value of Moon's securities at the beginning of the year with and without leverage given that financial distress is costly. Without Leverage Failure With Leverage Failure $75 Success Success $150 Debt value $250 $250 Equity value $90 $100 $0 Total to all investors $90 $250 $75
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
Transcribed Image Text:a. Consider the following outcomes both for the following scenarios with and
without leverage for Moon Industries' new venture. Assume Moon's new venture
is equally likely to succeed or to fail. The risk-free rate is 4%. The venture has a
beta of 0 and the cost of capital is equal to the risk-free rate. Compute the value of
Moon's securities at the beginning of the year with and without leverage.
With Leverage
Without Leverage
Failure
Failure
$90
$0
$90
Success
Success
$150
Debt value
$250
$250
$90
$90
$100
$250
Equity value
Total to all investors
b. Now assume that the costs of financial distress is $15 million. Compute the value
of Moon's securities at the beginning of the year with and without leverage given
that financial distress is costly.
Without Leverage
Failure
With Leverage
Success
Success
Failure
Debt value
$150
$75
$0
$75
Equity value
$250
$90
$100
Total to all investors
$250
$90
$250
4.
Transcribed Image Text:a. Consider the following outcomes both for the following scenarios with and
without leverage for Moon Industries' new venture. Assume Moon's new venture
is equally likely to succeed or to fail. The risk-free rate is 4%. The venture has a
beta of 0 and the cost of capital is equal to the risk-free rate. Compute the value of
Moon's securities at the beginning of the year with and without leverage.
With Leverage
Without Leverage
Failure
Failure
$90
$0
$90
Success
Success
$150
Debt value
$250
$250
$90
$90
$100
$250
Equity value
Total to all investors
b. Now assume that the costs of financial distress is $15 million. Compute the value
of Moon's securities at the beginning of the year with and without leverage given
that financial distress is costly.
Without Leverage
Failure
With Leverage
Success
Success
Failure
Debt value
$150
$75
$0
$75
Equity value
$250
$90
$100
Total to all investors
$250
$90
$250
4.
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