Hello,
In this problem, could you please explain to me why for question a we use the cost of capital to discount the current market value of the unlevered equity instead of the risk free ?
home / study / business / finance / finance questions and answers / acort industries owns assets that will have a(n) 65% probability of having a market... Question: Acort Industries owns assets that will have a(n) 65% probability ... Acort Industries owns assets that will have a(n) 65% probability of having a market value of $50 million in one year. There is a 35% chance that the assets will be worth only $20 million. The current risk-free rate is 7%, and Acort's assets have a cost of capital of 14% a. If Acort is unlevered, what is the current market value of its equity? b. Suppose instead that Acort has debt with a face value of $14 million due in one year. According to MM, what is the value of Acort's equity in this case? c. What is the expected return of Acort's equity without leverage? What is the expected return of Acort's equity with leverage? d. What is the lowest possible realized return of Acort's equity with and without leverage? Show transcribed image text Expert Answer satyach answered this 17,343 answers Was this answer helpful? 30 a) Market value of its equity $ 34.649 =(50*65%+20*35%)/(1+14%) b) Value of its equity 15.957 -34.649-20/(1+7%) c) Expected return of equity without leverage 14.00% =(50*65%+20*35%)/34.649-1 22.20% =(50*65%+20*35%-20)/15.957-1 Expected return of equity with leverage d) Lowest possible realized return of equity without leverage -42.28% -20/34.649-1 -100.00% =0/15.957-1 Lowest possible realized return of equity with leverage *Please rate thumbs up home / study / business / finance / finance questions and answers / acort industries owns assets that will have a(n) 65% probability of having a market... Question: Acort Industries owns assets that will have a(n) 65% probability ... Acort Industries owns assets that will have a(n) 65% probability of having a market value of $50 million in one year. There is a 35% chance that the assets will be worth only $20 million. The current risk-free rate is 7%, and Acort's assets have a cost of capital of 14% a. If Acort is unlevered, what is the current market value of its equity? b. Suppose instead that Acort has debt with a face value of $14 million due in one year. According to MM, what is the value of Acort's equity in this case? c. What is the expected return of Acort's equity without leverage? What is the expected return of Acort's equity with leverage? d. What is the lowest possible realized return of Acort's equity with and without leverage? Show transcribed image text Expert Answer satyach answered this 17,343 answers Was this answer helpful? 30 a) Market value of its equity $ 34.649 =(50*65%+20*35%)/(1+14%) b) Value of its equity 15.957 -34.649-20/(1+7%) c) Expected return of equity without leverage 14.00% =(50*65%+20*35%)/34.649-1 22.20% =(50*65%+20*35%-20)/15.957-1 Expected return of equity with leverage d) Lowest possible realized return of equity without leverage -42.28% -20/34.649-1 -100.00% =0/15.957-1 Lowest possible realized return of equity with leverage *Please rate thumbs up
