Question
Monsters Incorporated (MI) in ready to launch a new product. Depending upon the success of this product, MI will have a value of either $75
Monsters Incorporated (MI) in ready to launch a new product. Depending upon the success of this
product, MI will have a value of either $75 million, $125 million, or $181 million, with each outcome
being equally likely. The cash flows are unrelated to the state of the economy (i.e. risk from the project
is diversifiable) so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is
currently 5%. Assume that the capital markets are perfect.
Assuming that in the event of default, 20% of the value of MI's assets will be lost in bankruptcy costs,
the initial value of MI's equity without leverage is:
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