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Mini Case 4 . 1 Consider a firm with a single asset - an office building, which the firm has been leasing. The firm's sole

Mini Case 4.1 Consider a firm with a single asset - an office building, which the firm has been leasing.
The firm's sole liability is a debt of EUR 40 million due in one year. If left unchanged over the next
year, the office building will generate a free cash flow of EUR 20 million through the leasing business
in one year. The firm also has the option to discontinue the leasing business and renovate the office
building into a luxury hotel at an upfront cost of EUR 40 million. The new hotel will generate a free
cash flow of EUR 70 million in one year. The risk-free interest rate is 6%, and all market participants
are risk neutral. Assume there are no taxes. Answer the following questions:
a. If the firm chooses to leave the building unchanged, what is the value of the firm's equity today?
What is the value of the debt today?
b. What is the NPV of renovating the building?
c. Suppose the firm raises $40 million from equity holders to renovate the building. If the firm
renovates the building, what is the value of the firm's equity today? What is the value of the
firm's debt today?
d. Given your answer to part (c), would equity holders be willing to provide the $40 million
needed to renovate the building?
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