Question

Sunburn Sunscreen has a zero coupon bond issue outstanding with a $28,000 face value that matures in one year. The current market value of the firm’s assets is $29,900. The standard deviation of the return on the firm’s assets is 34 percent per year, and the annual risk-free rate is 5 percent per year, compounded continuously. The firm is considering two mutually exclusive investments. Project A has an NPV of $2,300, and Project B has an NPV of $3,200. As the result of taking Project A, the standard deviation of the return on the firm’s assets will increase to 51 percent per year. If Project B is taken, the standard deviation will fall to 31 percent per year.

  

a-1	What is the value of the firm’s equity and debt if Project A is undertaken? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	Market value
Equity	$
Debt	$

  

a-2	What is the value of the firm’s equity and debt if Project B is undertaken? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	Market value
Equity	$
Debt	$

  

b.	Which project would the stockholders prefer?
	Project B Project A

  

c.	Suppose the stockholders and bondholders are in fact the same group of investors. Would this affect your answer to (b)?
	No Yes

Answer 1