Question

Wrigley Company is considering an investment project that generates a cash flow of $13,000 next year if the economy is favorable but generates only $6,000 if the economy is unfavorable. The probability of favorable economy is 70% and of unfavorable economy is 30%. The project will last only one year and be closed after that. The cost of investment is $10,000 and Star Ventures plans to finance the project with $2,000 of equity and $8,000 of debt. Assuming the discount rates of both equity and debt are 0%. What is the expected cash flow to Star Ventures' shareholders if the company invests in the project?

		$0
		$2,900
		$3,500
		$4,200
		$7,500

Answer 1

	Particulars	Economy Favorable	Economy UNFavorable
	Cash flow	$                  13,000.00	$                          6,000.00
	Probability	0.7	0.3
	Cost of Investment	$                  10,000.00	$                        10,000.00
	Equity	$                    2,000.00
	Debt	$                    8,000.00
	Expected Cash flow	Sum of probable outcomes
		= 13000 X 0.7 + 6000 X 0.3
		$                  10,900.00
1	Expected Cash flow for Debt		$8,000.00
	As there Discount rate is 0% they will receive in return the invested amount without any increased income
2	Expected Cash flow for Equity		$ 2,900.00
	Balance after providing Debt is the cash flow for Equity Share holders