Sunburn Sunscreen has a zero coupon bond issue outstanding with a face value of

Question

Sunburn Sunscreen has a zero coupon bond issue outstanding with a face value of $29,000 that matures in one year. The current market value of the firm's assets is $30,700. 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 $2,200, and Project B has an NPV of $3,100. As the result of taking Project A, the standard deviation of the return on the firm's assets will increase to 49 percent per year. If Project B is taken, the standard deviation will fall to 30 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 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 answers to 2 decimal places, e.g., 32.16.) Market value Equity Debt

Explanation / Answer

First, we need to find the value of assets under both the Project A and Project B by using the following equation: We need to calculate value of the firm’s equity and debt if project A or project B is undertaken using the following information: ASSETS= 30700 FACE VALUE OF DEBT= 29000 RISK FREE RATE= 6% PER YEAR MATURITY= 1 YEAR NPV PROJECT A= 2200 STANDARD DEVIATION A 49% PER YEAR NPV PROJECT B= 3100 STANDARD DEVIATION B 30% PER YEAR Substitute the values in the value of assets formula: VALUE OF ASSETS=ASSETS OF FIRM+NPV OF PROJECT VALUE OF ASSETS UNDER PROJECT A= $30700+$2200 $        32,900 VALUE OF ASSETS UNDER PROJECT B= $30700+$3100 $        33,800 a.project A undertaken equity=total assets of project A less debt $          5,542 debt=PV of bonds outstanding @6% annuity $29000/1.06 $        27,358 total $        32,900 a.project B undertaken equity=total assets of project A less debt $          6,442 debt=PV of bonds outstanding @6% annuity $29000/1.06 $        27,358 total $        33,800

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