Suppose the initial $91,325 is instead raised by borrowing at the risk-free inte

Question

Suppose the initial $91,325 is instead raised by borrowing at the risk-free interest rate. What are the cash flows of the levered equity, what is its initial value and what is the initial equity according to MM?

The cash flows of the levered equity and its initial values according to MM are: (Round to the nearest dollar.)

Date O

Date 1

Initial Value

Cash Flow Strong Economy

Cash flow Weak Economy

Debt

$91,325

$114,156

$114,156

Levered Equity

$30,404

$

$

Date O

Date 1

Initial Value

Cash Flow Strong Economy

Cash flow Weak Economy

Debt

$91,325

$114,156

$114,156

Levered Equity

$30,404

$

$

Explanation / Answer

rE is the required rate of return on equity, or cost of equity. rD is the required rate of return on borrowings, or cost of debt. D/E is the debt-to-equity ratio. Date O Date 1 Initial Value Cash Flow Strong Economy Cash flow Weak Economy Debt $91,325 $114,156 $114,156 Levered Equity $30,404                                           38,001.33 38001.33156 Debt /Equity 3.0037 3.004 38001.33156 workings (114156/3.004) (114156/3.004)

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