Consider a project with free cash flow in one year of

$130,000

in a weak market or

$180,000

in a strong market, with each outcome being equally likely. The initial investment required for the project is

$100,000,

and the project's unlevered cost of capital is

20%.

The risk-free interest rate is

10%.

(Assume no taxes or distress costs.)

a. What is 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 flow of the project in one year. How much money can be raised in this

waythat

is, what is the initial market value of the unlevered equity?

c. Suppose the initial

$100,000

is instead raised by borrowing at the risk-free interest rate. What are the cash flow 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.