Tern Corporation expects cash flows from its risky assets in one years time of either $110 million or $30 million, with equal probability. The firm also has debt with face value $50 million due in one year.

Tern is considering a new project that would require an investment of $16 million today and would result in a certain cash flow in one years time of $24 million. Tern has $16 million in cash which can be used to invest in the project if it is accepted. If the cash is not invested, it will be distributed to equityholders as a dividend.

Investors are all risk neutral and the risk free rate is zero.

(a) What are the expected values of the firm's equity and debt now? (4 marks)

(b) What are the expected values of the firm's equity and debt if the new project is undertaken? What is the incremental value to the equityholders if the project is undertaken? (5 marks)

(c) Assume that if Tern does not undertake the project, it could sell off some of its risky assets for $20 million in cash. Tern can pay this $20 million and its existing cash of $16 million to its equityholders as a dividend. If the firm chooses to do this, the cash flows from its risky assets in one years time will be reduced to either $80 million or zero with equal probability. What will be the expected values of the firms equity and debt? (5 marks)

5. Tern Corporation expects cash flows from its risky assets in one year's time of either $110 million or $30 million, with equal probability. The firm also has debt with face value $50 million due in one year. Tern is considering a new project that would require an investment of $16 million today and would result in a certain cash flow in one year's time of $24 million. Tern has $16 million in cash which can be used to invest in the project if it is accepted. If the cash is not invested, it will be distributed to equityholders as a dividend. Investors are all risk neutral and the risk free rate is zero. (a) What are the expected values of the firm's equity and debt now? (4 marks) (b) What are the expected values of the firm's equity and debt if the new project is undertaken? What is the incremental value to the equityholders if the project is undertaken? (5 marks) (c) Assume that if Tern does not undertake the project, it could sell off some of its risky assets for $20 million in cash. Tern can pay this $20 million and its existing cash of $16 million to its equityholders as a dividend. If the firm chooses to do this, the cash flows from its risky assets in one year's time will be reduced to either $80 million or zero with equal probability. What will be the expected values of the firm's equity and debt