Question
(Chap 14) Assume a firm has cash of $20 and a project (Project A) that is either worth $150 or $60 (50% chance of each).
(Chap 14) Assume a firm has cash of $20 and a project (Project A) that is either worth $150 or $60 (50% chance of each). The firm owes $120 to the bank. Similar to the example in class, the following shows the value of assets, debt, and equity where the amounts are calculated based on the good state, the bad state, and on expected values.
Base case market value balance sheet in the good state (50% chance)
Cash | $20 | Debt | $120 |
Project A | $150 | Equity | $50 |
Total | $170 | Total | $170 |
Base case market value balance sheet in the bad state (50% chance)
Cash | $20 | Debt | $80 |
Project A | $60 | Equity | $0 |
Total | $80 | Total | $80 |
Base case market value balance sheet based on expected values
Cash | $20 | Debt | $100 |
Project A | $105 | Equity | $25 |
Total | $125 | Total | $125 |
Now assume the firm is considering a new project (Project B) which requires an initial investment of $5. If the new project is accepted, the $5 will be paid for using the firms cash. Project B has a $41 cash flow in the good state and a $8 cash flow In the bad state. What is the expected value of the firms debt if the firm decides to accept Project B?
Enter your answer to two decimal places (e.g., $1250.00). Full credit: within $0.05 of the correct answer (e.g., $1249.95 - $1250.05). Partial credit: within $0.25 of the correct answer (e.g., $1249.75 - $1250.25).
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