Question
Consider a firm with the following financial characteristics: Assets Book Value Market Value Liabilities and Equity Book Value Market Value Cash $1,000 $1,000 long-term bonds
Consider a firm with the following financial characteristics:
Assets | Book Value | Market Value | Liabilities and Equity | Book Value | Market Value |
Cash | $1,000 | $1,000 | long-term bonds | $1,500 | $1,500 |
Fixed Assets | 2,000 | 500 | equity | 1,500 | - |
Total | $3,000 | $1,500 | total | $3,000 | $1,500 |
A. Assuming the firm is liquidated today, how much do the long-term bondholders and shareholders receive?
B.Consider a very risky project the firm can undertake with the below payoffs and probabilities. Assume the cost of the investment is $1,000 and the required return is 30%, what is the NPV of the project? What is the payoff to bondholders and shareholders in the case where the project is successful AND in the case where the project is unsuccessful?
The Gamble | Probability | |
Successful Project | 10% | $10,000 |
Unsuccessful Project | 90% | - |
C.The firm also has the ability to undertake a project sponsored by the US government. The cost of the project is $2,000 and the guaranteed return is $2,500. The firm has a required rate of return of 5%. If the decision is made by the equity holders, should the firm undertake the project? Why or why not? (Show calculations/payouts to bondholders and shareholders.)
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