Wrigley Company is considering an investment project that generates a cash flow

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

$0

$2,900

$3,500

$4,200

$7,500

Explanation / Answer

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

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