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he cost of project X is $100, and it would enerate $120 in one year without risk. If a firm oes not invest in project X, then the firm value in ne year would be at $500 in a boom and $100 if s at recession. The chance of a boom is 50%, and he chance of recession is 50%. The firm has a one

he cost of project X is $100, and it would enerate $120 in one year without risk. If a firm oes not invest in project X, then the firm value in ne year would be at $500 in a boom and $100 if s at recession. The chance of a boom is 50%, and he chance of recession is 50%. The firm has a one

Essentials Of Investments
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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The cost of project X is $100, and it would generate $120 in one year without risk. If a firm does not invest in project X, then the firm value in one year would be at $500 in a boom and $100 if it is at recession. The chance of a boom is 50%, and the chance of recession is 50%. The firm has a one- year debt, which would be matured in one year at $300. If project X is accepted, the cost is required to be financed by additional equity since the firm does not have cash recently. Assume the financial manager would maximize the shareholders' wealth. If the appropriate discount rate is 10%, would the manager accept the project, and would there be any under-investment problem? Explain it with calculation.
Transcribed Image Text:The cost of project X is $100, and it would generate $120 in one year without risk. If a firm does not invest in project X, then the firm value in one year would be at $500 in a boom and $100 if it is at recession. The chance of a boom is 50%, and the chance of recession is 50%. The firm has a one- year debt, which would be matured in one year at $300. If project X is accepted, the cost is required to be financed by additional equity since the firm does not have cash recently. Assume the financial manager would maximize the shareholders' wealth. If the appropriate discount rate is 10%, would the manager accept the project, and would there be any under-investment problem? Explain it with calculation.
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