Question
17. Braxton Inc. is considering a project with free cash flows in one year of $146,675 in a weak market or $199,415 in a strong
17. Braxton Inc. is considering a project with free cash flows in one year of $146,675 in a weak\ market or $199,415 in a strong market, with each outcome being equally likely. The initial\ investment required for the project is $105,000, and the projects unlevered cost of capital is\ 14%. The risk-free interest rate is 4% (Assume no taxes or distress costs).\ a. Whats the NPV of this project?\ b. 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. How much money can be raised in this way---that is, what\ is the initial market value of the unlevered equity?\ c. Suppose the initial $105,000 is instead raised by borrowing at the risk free\ interest rate. What are the cash flows of the levered equity in a weak market and a\ strong market at the end of year 1, and what is its initial market value of the\ levered equity according to MM? Assume that the risk-free rate remains at its\ current level and ignore any arbitrage opportunity.
17. Braxton Inc. is considering a project with free cash flows in one year of $146,675 in a weak\ market or $199,415 in a strong market, with each outcome being equally likely. The initial\ investment required for the project is $105,000, and the projects unlevered cost of capital is\ 14%. The risk-free interest rate is 4% (Assume no taxes or distress costs).\ a. Whats the NPV of this project?\ b. 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. How much money can be raised in this way---that is, what\ is the initial market value of the unlevered equity?\ c. Suppose the initial $105,000 is instead raised by borrowing at the risk free\ interest rate. What are the cash flows of the levered equity in a weak market and a\ strong market at the end of year 1, and what is its initial market value of the\ levered equity according to MM? Assume that the risk-free rate remains at its\ current level and ignore any arbitrage opportunity.
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