Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
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Chapter 16, Problem 18P
Consider a firm whose only asset is a plot of vacant land, and whose only liability is debt of $15 million due in one year. If left vacant, the land will be worth $10 million in one year. Alternatively, the firm can develop the land at an upfront cost of $20 million. The developed land will be worth $35 million in one year. Suppose the risk-free interest rate is 10%, assume all cash flows are risk-free, and assume 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 $20 million from 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 $20 million needed to develop the land?
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Consider a firm whose only asset is a plot of vacant land, and whose only liability is debt of $15.2 million due in one year. If left vacant, the land will be worth $10.2 million in one year. Alternatively, the firm can develop the land at an up-front cost of $19.6 million. The developed the land will be worth $35.9 million in one year.
Suppose the risk-free interest rate is 9.7%, assume 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,…
Consider an entrepreneur who plans to invest in a project that requires an initial
investment of $1,800 this year. The project will generate either $1,600 or $4,200
next year. The cash flows of the project depend on whether the economy is weak or
strong. Both scenarios are equally likely. The risk-free rate is 4% and the risk
premium of the project is 12%. Assume perfect capital markets. Now assume that
the entrepreneur will borrow $400 at 5% interest rate to finance the project. The
cost of equity of the project is closest to:
16.60%
17.72%
18.29%
19.43%
None of the above
Consider a project with free cash flows in one year of $130,000 in a weak market or $180,000 in a strong market, with each outcome being equally likely. The initial investment required for the project is $100,000, and the project's unlevered cost of
capital is 20%. The risk-free interest rate is 10%. (Assume no taxes or distress costs.)
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 $100,000 is instead raised by borrowing at the risk-free interest rate. What are the cash flows of the levered equity in a weak market and a strong market at the end of year 1, and what is its initial market value of the levered
equity according to MM?
Assume that the risk-free rate remains at its…
Chapter 16 Solutions
Corporate Finance
Ch. 16.1 - Prob. 1CCCh. 16.1 - Does the risk of default reduce the value of the...Ch. 16.2 - If a firm files for bankruptcy under Chapter 11 of...Ch. 16.2 - Why are the losses of debt holders whose claims...Ch. 16.3 - Prob. 1CCCh. 16.3 - True or False: If bankruptcy costs are only...Ch. 16.4 - Prob. 1CCCh. 16.4 - According to the trade-off theory, all else being...Ch. 16.5 - Prob. 1CCCh. 16.5 - Why would debt holders desire covenants that...
Ch. 16.6 - Prob. 1CCCh. 16.6 - Prob. 2CCCh. 16.7 - Prob. 1CCCh. 16.7 - Prob. 2CCCh. 16.8 - How does asymmetric information explain the...Ch. 16.8 - Prob. 2CCCh. 16.9 - Prob. 1CCCh. 16.9 - Prob. 2CCCh. 16 - Gladstone Corporation is about to launch a new...Ch. 16 - Baruk Industries has no cash and a debt obligation...Ch. 16 - When a firm defaults on its debt, debt holders...Ch. 16 - Prob. 4PCh. 16 - Prob. 5PCh. 16 - Suppose Tefco Corp. has a value of 100 million if...Ch. 16 - You have received two job offers. Firm A offers to...Ch. 16 - As in Problem 1, Gladstone Corporation is about to...Ch. 16 - Kohwe Corporation plans to issue equity to raise...Ch. 16 - Prob. 10PCh. 16 - Prob. 11PCh. 16 - Hawar International is a shipping firm with a...Ch. 16 - Your firm is considering issuing one-year debt,...Ch. 16 - Marpor Industries has no debt and expects to...Ch. 16 - Real estate purchases are often financed with at...Ch. 16 - On May 14, 2008, General Motors paid a dividend of...Ch. 16 - Prob. 17PCh. 16 - Consider a firm whose only asset is a plot of...Ch. 16 - Prob. 19PCh. 16 - Prob. 20PCh. 16 - Prob. 21PCh. 16 - Consider the setting of Problem 21 , and suppose...Ch. 16 - Consider the setting of Problems 21 and 22, and...Ch. 16 - You own your own firm, and you want to raise 30...Ch. 16 - Empire Industries forecasts net income this coming...Ch. 16 - Ralston Enterprises has assets that will have a...Ch. 16 - Prob. 27PCh. 16 - If it is managed efficiently, Remel Inc. will have...Ch. 16 - Which of the following industries have low optimal...Ch. 16 - According to the managerial entrenchment theory,...Ch. 16 - Info Systems Technology (IST) manufactures...Ch. 16 - Prob. 32PCh. 16 - Prob. 33P
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