Consider a firm whose only asset is a plot of vacant land, and whose only liabil
ID: 2658598 • Letter: C
Question
Consider a firm whose only asset is a plot of vacant land, and whose only liability is debt of $14.8 million due in one year. If left vacant, the land will be worth $9.9 million in one year. Altematively, the firm can develop the land at an up-front cost of $19.9 million. The developed the land will be worth $35.5 million in one year. Suppose the risk-free interest rate is 10.2%, cash flows are risk-free, and there are no taxes. a. If the firm chooses not to develop the land, what is the value of the firm's equity today? What is the value of the debt today? b. What is the NPV of developing the land? os temr9ion tmthe holdertheland.i th fm dvelosland, what is the valive of the firm's oquily today? What ista the firm's cebt today? d. Given your answer to part (c), would equity holders be willing to provide the $19.9 million needed to develop the land?Explanation / Answer
a.
The firm has has only one asset and this implies that it has no Equity, Therefore value of equity=0
It is assumed that firm will use the proceeds from selling the Vacant plot to pay off its debt, Therefore Value of Debt today=9.9M/1.102=8.98 Million
b.
NPV of Developing the Land=(35.5M-9.9M)/1.102-19.9M=3.33 Million
c.
Value of Debt=14.8M/1.102=13.43 Million
Value of equity=(35.5M-14.8M)/1.102=18.78 Million
d.
Equity holders will not be willing to accept the deal, because for them it is a negative NPV investment (18.78M – 19.9M <0).
a.
The firm has has only one asset and this implies that it has no Equity, Therefore value of equity=0
It is assumed that firm will use the proceeds from selling the Vacant plot to pay off its debt, Therefore Value of Debt today=9.9M/1.102=8.98 Million
b.
NPV of Developing the Land=(35.5M-9.9M)/1.102-19.9M=3.33 Million
c.
Value of Debt=14.8M/1.102=13.43 Million
Value of equity=(35.5M-14.8M)/1.102=18.78 Million
d.
Equity holders will not be willing to accept the deal, because for them it is a negative NPV investment (18.78M – 19.9M <0).
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