Question
Suppose that there is project which will generate cash flows of either $1800 or $1420 next year, depending on whether the economy is strong or
Suppose that there is project which will generate cash flows of either $1800 or $1420 next year, depending on whether the economy is strong or weak. Given a risk-free interest rate of 5% and a risk premium of 10%, the cost of capital for this project is 15%. Assume that the manager borrows $900 when financing the project.
a) According to Modigliani and Miller, what should the value of the equity be?
b) What is the return on the equity when the economy is strong?
c) What is the return on the equity when the economy is weak?
d) What is the expected return?
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