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Sunburn Sunscreen has a zero coupon bond issue outstanding with a $28,000 face value that matures in one year. The current market value of the

Sunburn Sunscreen has a zero coupon bond issue outstanding with a $28,000 face value that matures in one year. The current market value of the firms assets is $29,900. The standard deviation of the return on the firms assets is 34 percent per year, and the annual risk-free rate is 5 percent per year, compounded continuously. The firm is considering two mutually exclusive investments. Project A has an NPV of $2,300, and Project B has an NPV of $3,200. As the result of taking Project A, the standard deviation of the return on the firms assets will increase to 51 percent per year. If Project B is taken, the standard deviation will fall to 31 percent per year.

a-1

What is the value of the firms equity and debt if Project A is undertaken? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Market value
Equity $
Debt $

a-2

What is the value of the firms equity and debt if Project B is undertaken? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Market value
Equity $
Debt $

b. Which project would the stockholders prefer?
  • Project B

  • Project A

c.

Suppose the stockholders and bondholders are in fact the same group of investors. Would this affect your answer to (b)?

  • No

  • Yes

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