Question

Sunburn Sunscreen has a zero coupon bond issue outstanding with a $23,000 face value that matures in one year. The current market value of the firm’s assets is $25,100. The standard deviation of the return on the firm’s assets is 34 percent per year, and the annual risk-free rate is 6 percent per year, compounded continuously. The firm is considering two mutually exclusive investments. Project A has an NPV of $2,100, and Project B has an NPV of $2,900. As the result of taking Project A, the standard deviation of the return on the firm’s assets will increase to 46 percent per year. If Project B is taken, the standard deviation will fall to 28 percent per year.

  

a-1.	What is the value of the firm’s equity and debt if Project A is undertaken? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

  

	Market value
Equity	$
Debt	$

  

a-2.	What is the value of the firm’s equity and debt if Project B is undertaken? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

  

	Market value
Equity	$
Debt	$

  

b.	Which project would the stockholders prefer?
	Project A Project B

Answer 1