In: Finance
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?
Given,
Unlevered cost of capital (r) = 16% or 0.16
risk free rate = 12%
Initial investment = $ 85000
Solution :-