Consider a project with free cash flows in one year of $148,100 or $180,200, with each outcome being equally likely. The initial investment required for the project is $96,900, and the project's cost of capital is 16%. The risk-free interest rate is 12%.
Consider a project with free cash flows in one year of $148,100 or $180,200, with each outcome being equally likely. The initial investment required for the project is $96,900, and the project's cost of capital is 16%. The risk-free interest rate is 12%.
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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M4
Transcribed Image Text:Consider a project with free cash flows in one year
of $148,100 or $180,200, with each outcome being
equally likely. The initial investment required for the
project is $96,900, and the project's cost of capital
is 16%. The risk-free interest rate is 12%.
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 flows 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 $96,900 is instead raised by
borrowing at the risk-free interest rate. What are
the cash flows of the levered equity, what is its
initial value and what is the initial equity according
to MM?
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