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Using the Modigliani-Miller (MM) theory in a perfect market, firm A wants to evaluate an one-year project and how to finance it. The firm has

Using the Modigliani-Miller (MM) theory in a perfect market, firm A wants to evaluate an one-year project and how to finance it. The firm has only this project and it will generate free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%.

(i) What is the net present value (NPV) of this project?

(ii) Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. What is the value of the unlevered equity for this project?

(iii) Suppose that to raise the funds for the initial investment, the firm borrows $80,000 at the risk-free rate. What is the value of the firm's levered equity? What is the cost of the levered equity and the cost of capital (WACC) of the firm?

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