Question
Consider the entrepreneur described in Section 14.1 (and referenced in Tables 14.1-14.3). Suppose she funds the project by borrowing $750 rather than $500. EXAMPLES: TABLE
Consider the entrepreneur described in Section 14.1 (and referenced in Tables 14.1-14.3). Suppose she funds the project by borrowing $750 rather than $500.
EXAMPLES:
TABLE 14.1 The Project Cash Flows
Date 0 | Date 1 | |
| Strong Economy | Weak Economy |
?$800 | $1400 | $900 |
|
|
|
TABLE 14.2 Cash Flows and Returns for Unlevered Equity
Date 0 | Date 1: Cash Flows | Date 1: Returns | |||
| Initial Value | Strong Economy | Weak Economy | Strong Economy | Weak Economy |
| |||||
Unlevered equity | $1000 | $1400 | $900 | 40% | ?10% |
TABLE 14.3 Values and Cash Flows for Debt and Equity of the Levered Firm
| Date 0 | Date 1: Cash Flows | |
| Initial Value | Strong Economy | Weak Economy |
Debt Levered equity | $500 E = ? | $525 $875 | $525 $375 |
Firm | $1000 | $1400 | $900 |
a. According to MM Proposition I, what is the value of the equity? What are its cash flows if the economy is strong? What are its cash flows if the economy is weak? PLEASE EXPLAIN
b. What is the return of the equity in each case? What is its expected return? PLEASE SHOW CALCULATIONS
c. What is the risk premium of equity in each case? What is the sensitivity of the levered equity return to systematic risk? How does its sensitivity compare to that of unlevered equity? How does its risk premium compare to that of unlevered equity? PLEAE EXPLAIN AND SHOW CALCULATIONS
d. What is the debt-equity ratio of the firm in this case? SHOW CALCULATIONS
e. What is the firm's WACC in this case? SHOW CALCULATIONS
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