Q3:

(A) There is 60% chance that Australia will be in recession next year. Project MARSa high tech venturewill have free cash flows of AUD 100,000 in one year if there is a recession. If there is no recession, the free cash flow will be AUD 120,000 in one year. The initial investment required for the project is AUD 80,000. If MARS raises the required funds for initial investment from the public debt market at risk-free rate of interest, what would be the cash flow that equity holders of MARS will receive in one year? What would be the cost of capital for the firm's levered equity? The project's cost of capital is 20%. The risk-free interest rate is 5%.

Show your calculations.

(B) Roxy Electronics operates in a perfect capital market. It wants to issue new equities and repay all the outstanding debt. As a shareholder, you do not like this decision. What would you do in this circumstance and why? Answer this question using the following information. Roxy has 20 million shares outstanding. The market capitalization $1200 million, and the amount of debt outstanding is $600 million. You have 250 shares of Roxy.

Show your calculations.

(C) Do you agree with the following statement? Why or why not?

The total value of a firm is equal to the market value of the total cash flows generated by its assets in a perfect capital market. If the dividend policy remains unchanged, increased leverage can affect the total value of the firm.