Consider a firm that only has a patent as its asset. If not developed any further, the value of the patent will only be $19 million at the end of the year. The firm has long-term debt of $28 million, which is due at the end of the year. However, the firm can develop its patent with an upfront cost of $24.5 million. The developed patent will have a value of $50.25 million at the end of the year. Suppose the risk-free interest rate is 12%, assume all cash flows are risk-free, and assume there are no taxes.

 

a.   What are the firm's debt and equity values today if it decides not to develop its patent any further 

b.   Let us assume that the firm decides to develop its patent further. What is the NPV of developing the patent )?

c.   Suppose the firm raises $24.5 million from equity holders to develop the patent. In this scenario, calculate the firm's debt and equity values as of today .