10 8. Suppose there are no taxes and no transaction costs. Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows. A biotechnology company initiates new medicine development project for a year. The amount of initial investment is $20,000. The company expects to generate cash flow $32,000 and $16,000. These cash flows depend on their success of development and of marketing activities. The chance of successful and undesirable cash generation is 80% and 20%, respectively. Currently, the annual effective risk-free rate is 4% and the risk premium is 9%. (c) [5 points) Out of maximum available funding amount, suppose the manager in this biotechnology company decides to borrow $ 10,000 initially at the risk-free rate. What are the cash flows of the levered equity and debt holder? (d) [5 points) Based on part (e) question, calculate the return of the investment for the levered equity and the debt holder with different cash generation scenario. Then calculate the expected return for the levered equity and the debt holder. (e) [2.5 points) What would be happened to the cost of the firm? Is the resulting cost of the firm consistent with Modigliani-Miller Preposition? 10 8. Suppose there are no taxes and no transaction costs. Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows. A biotechnology company initiates new medicine development project for a year. The amount of initial investment is $20,000. The company expects to generate cash flow $32,000 and $16,000. These cash flows depend on their success of development and of marketing activities. The chance of successful and undesirable cash generation is 80% and 20%, respectively. Currently, the annual effective risk-free rate is 4% and the risk premium is 9%. (c) [5 points) Out of maximum available funding amount, suppose the manager in this biotechnology company decides to borrow $ 10,000 initially at the risk-free rate. What are the cash flows of the levered equity and debt holder? (d) [5 points) Based on part (e) question, calculate the return of the investment for the levered equity and the debt holder with different cash generation scenario. Then calculate the expected return for the levered equity and the debt holder. (e) [2.5 points) What would be happened to the cost of the firm? Is the resulting cost of the firm consistent with Modigliani-Miller Preposition