You are an entrepreneur starting a biotechnology firm. If your research is succe
ID: 3173536 • Letter: Y
Question
You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $30 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $2.0 million. Investors are willing to provide you with $2.0 million in initial capital in exchange for 50%
of the unlevered equity in the firm.
a. What is the total market value of the firm without leverage?
b. Suppose you borrow $1.0 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $1.0
million you need?
c. What is the value of your share of the firm's equity in cases
(a)
and
(b)?
Explanation / Answer
a)
Total value of equity: 2 * $2m = $4m
b)
MM says total value of firm is still $4 million.
$1 million of debt impliestotal value of equity is $3 million.
Therefore, 33% of equity must besold to raise $1 million
c)
In (a), 50% × $4m = $2m.
In (b), 2/3 × $3m = $2m.
Thus, in a perfect market the choice of capital structure does not affect the value to the entrepreneur.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.