Question

Consider a project with free cash flows in one year of $ 133 comma 513 in a weak market or $ 194 comma 564 in a strong​ market, with each outcome being equally likely. The initial investment required for the project is $ 85,000​, and the​ project's unlevered cost of capital is 16 %. The​ risk-free interest rate is 12 %. ​(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 waylong dashthat ​is, what is the initial market value of the unlevered​ equity?  

c. Suppose the initial $ 85 comma 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 current level and ignore any arbitrage opportunity.

a. What is the NPV of this​ project? The NPV is ​$ 56413. ​(Round to the nearest​ dollar.)

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 waylong dashthat ​is, what is the initial market value of the unlevered​ equity?  

Answer 1

Given,

Unlevered cost of capital (r) = 16% or 0.16

risk free rate = 12%

Initial investment = $ 85000

Solution :-