Question
XYZ Industries owns assets that will have a(n) 80% probability of having a market value of $100 million in one year. There is a 20%
XYZ Industries owns assets that will have a(n) 80% probability of having a market value of $100 million in one year. There is a 20% chance that the assets will be worth only $50 million. The current risk-free rate is 4 %, and XYZ's assets have a cost of capital of 12%.
If the firm is unlevered, what is the current market value of its equity? Suppose that instead, XYZ has a debt with a face value of $40 million due in one year. According to M&M, what is the value of XYZs equity in this case? What is the expected return on equity without leverage? What is the expected return with leverage? What is the lowest possible realized return on equity with and without leverage?
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