Question
You expect your firm to be worth $100, $160, or $190 with probabilities 15%, 50% and 35% respectively. You can raise debt today if you
You expect your firm to be worth $100, $160, or $190 with probabilities 15%, 50% and 35% respectively. You can raise debt today if you promise to repay $175 one year from now. The expected return on this debt is 7%. If this is how you finance your firm, then your expected cost of equity is 25%. Assume perfect markets. Fill out the following table, assuming you utilize this capital structure. You can show work below the chart if you need additional room. Make sure your final answers are clear.
Scenario | Probability | Firm (100% Equity) | Debt | Equity |
Bad | 0.15 | 100 |
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Middle | 0.5 | 160 |
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Good | 0.35 | 190 |
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Expected Value |
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Value Today |
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Expected Return |
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