Question

Acort Industries owns assets that will have​ a(n)

80 %80%

probability of having a market value of

$ 54$54

million in one year. There is a

20 %20%

chance that the assets will be worth only

$ 24$24

million. The current​ risk-free rate is

2 %2%​,

and​ Acort's assets have a cost of capital of

4 %4%.

a. If Acort is​ unlevered, what is the current market value of its​ equity?

b. Suppose instead that Acort has debt with a face value of

$ 18$18

million due in one year. According to​ M&M, what is the value of​ Acort's equity in this​ case?

c. What is the expected return of​ Acort's equity without​ leverage? What is the expected return of​ Acort's equity with​ leverage?

d. What is the lowest possible realized return of​ Acort's equity with and without​ leverage?

Answer 1

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