Consider a project with free cash flows in one year of $132,445 or $168,043, wit

Question

Consider a project with free cash flows in one year of $132,445 or $168,043, with each outcome being equally likely. The initial investment required for the project is $100,641, and the project's cost of capital is 24%. The risk-free interest rate is 7%. The NPV of the project is $20,524 and the intitial market value of the unlevered equity is $121,165.

The cash flows of the levered equity and its initial values according to MM are:

                

Date 0 Date 1 Date 1 Initial Value Cash Flow Strong Economy Cash Flow Weak Economy Debt $100,641    ?    ? Levered Equity ?    ? ?

Explanation / Answer

  

(132445+168043)

2

=150244/1.24

=121164

Date 0 Date 1 Date 1 Initial Value Cash Flow Strong Economy Cash Flow Weak Economy Debt $100,641 168043-100641=67402 132445-100641=31804 Levered Equity

(132445+168043)

2

=150244/1.24

=121164

168043-121164=46879 132445-121164=11281

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