The Huck Glove Company manufactures the famous Flying Glove. If the winter is windy, then demand for glove will be high and free cash flow will be $5,000. (Assume that cash will flow at the end of the winter.) If the winter is not windy, then cash flow will be $3,000. Forecasters predict a 50% chance of a windy winter. The company has a debt with a principal of $4,000 that matures at the end of the winter. Assume that interest rates are zero. A scientist in the R&D department has designed a new glove that, when thrown, can hover for over 10 seconds. The Hover Glove project requires an investment of $500 immediately and will generate a cash flow of $900 at the end of the winter. Market research indicates that the Hover Glove will be so popular that there is no risk to the cash flows. Use this information to answer the following questions.

Part 1

Ignoring the hover glove project, what is the value of the companys equity (E) and its debt (D)?

E = $0

D = $

Part 2

What is the NPV of the Hover Glove project? (Hint: The expected payoff less the investment.)

NPV = $

Part 3

What are the expected cash flows to stockholders if the Hover Glove project is accepted? Ignore the cost of the investment in the Hover project and include cash flows from the original project, the Flying Glove.

Expected cash flows owners = $

Part 4

What are the expected cash flows to lenders if the Hover Glove project is accepted? Ignore the cost of the investment in the Hover project and dont forget to include cash flows from the Flying Glove.

Expected cash flows to lenders = $

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Question 2

Part 5

Using the values computed earlier, calculate the change in the expected cash flows to lenders (and owners) if the Hover Glove project is accepted. In the computation of excepted cash flows, we ignored the investment required to undertake the project. Investors will only invest $1 if they can get back at least $1. Do either the lenders or owners experience a change in expected cash flows that is larger than the Hover Glove investment of $500? If they do, then they would be willing to invest $500 in the project. Which stakeholder group is willing to invest in the Hover Glove project?

• lenders

  lenders

• owners

  owners

• both

  both

• neither