Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a project and...

Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a project and how to finance it. The project has free cash flows in one year (year 1) of $90 in a weak economy or $120 in a strong economy. There is 75% chance that the economy is strong. The initial investment required for the project is $80, and the project's cost of capital is 10%. The risk free interest rate is 5%. Suppose that to raise the funds for the initial investment, you can both raise some amount of levered equity and borrow $80 at the risk free interest rate. For the cost of the levered equity and the cost of capital (WACC) , which of the following statements is correct?

	A.	The cost of the levered equity is 56.32% and the cost of capital is 10.00%
	B.	The cost of the levered equity is 56.32% and the cost of capital is 15.00%
	C.	The cost of the levered equity is 27.96% and the cost of capital is 15.00%
	D.	The cost of the levered equity is 27.96% and the cost of capital is 10.00%

Expert Solution

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

AS TAXES ARE ABSENT, COST OF CAPITAL WILL REMAIN SAME = 10%

jeff jeffy answered 2 years ago

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Using the Modigliani-Miller (MM) theory in a perfect market, you want to evaluate a project and...

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