09 May WHAT IS THE MARKET VALUE OF THE UNLEVERED EQUITY?
Free Cash Flows and Unlevered Equity1. Consider a project with free cash flows in one year of $90 000 in a weak economy or $117 000 in a strong economy with each outcome being equally likely. The initial investment required for the project is $80 000 and the project’s cost of capital is 15%. The risk-free interest rate is 5%. What is the NPV? 2. Consider a project with free cash flows in one year of $90 000 in a weak economy or $117 000 in a strong economy with each outcome being equally likely. The initial investment required for the project is $80 000 and the project’s cost of capital is 15%. The risk-free interest rate is 5%. Suppose that to raise the funds for the initial investment the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. What is the market value of the unlevered equity?3. Consider two firms With and Without that have identical assets that generate identical cash flows. Without is an all-equity firm with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. According to MM Proposition 1 what is the stock price?4. Consider two firms With and Without that have identical assets that generate identical cash flows. Without is an all-equity firm with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. Assume that MM’s perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock?
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