Firm A has total assets with a market value of $300 million, and business assets account for 90% of the total assets, and cash available for investment accounts for the remaining 10%. The market value of the business assets is assumed to remain unchanged from year to year. The promised future value of the debt of Firm A, which is due in exactly a year, is $660 million. The promised rate of interest on Firm As debt is 10%. Recall that the promised future value of debt equals the sum of the principal and interest.

Firm B also has total assets with a market value of $300 million, and its business assets also account for 90% of the total assets, and cash available for investment accounts for the remaining 10%. The market value of the business assets is assumed to remain unchanged from year to year. The promised future value of the debt of Firm B, which is due in exactly a year, is $159 million. The promised rate of interest on Firm Bs debt is 6%. Recall that the promised future value of debt equals the sum of the principal and interest. Project X has a life of one year, and involves an outlay of $30 million. It will generate a cash inflow of $810 million in Event 1, which occurs with a probability of 0.03, and nothing otherwise. The cost of capital that takes the risk of the project into account is 80%.

Project Y also has a life of one year, and also involves an outlay of $30 million. It will produce a cash inflow of $42 million next year with certainty. The risk free rate is 5%.

Work out the NPV of both projects, and complete the four tables below, the first table with the assumption that Firm A undertakes Project X, the second with the assumption that Firm A undertakes Project Y, the third table with the assumption that Firm B undertakes Project X, the fourth table with the assumption that Firm B undertakes Project Y.

Table 1: FIRM A: FV1 in $ millions with Project X EVENT PROBABILITY FV1(CF) FV1(Assets) FV1(Debt) FV1(Equity) Event 1 0.03 810 Otherwise 0 EXPECTED FUTURE VALUES

Table 2: FIRM A: FVs in $ millions with Project Y FV(CF) FV(Assets) FV(Debt) FV(Equity) 42 FUTURE VALUES

Table 3: FIRM B: FV1 in $ millions with Project X EVENT PROBABILITY FV1(CF) FV1(Assets) FV1(Debt) FV1(Equity) Event 1 0.03 810 Otherwise 0 EXPECTED FUTURE VALUES

Table 4: FIRM B: FVs in $ millions with Project Y FV(CF) FV(Assets) FV(Debt) FV(Equity) 42 FUTURE VALUES