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This document includes the solutions for questions related to the material covered in class for Chapter 14. Thus, you are not required to return this last problem set either. During the last week of classes we will go over questions on the final exam.
Please, do not forget to complete the teaching evaluations on-line at https://sete.unt.edu/
Corporate Finance: The Core (Berk/DeMarzo) Chapter 14 - Capital Structure in a Perfect Market
Use the information for the question(s) below. Consider a project with 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 projectʹs cost of capital is 15%. The risk-free interest rate is 5%.
1) 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. The market value of the unlevered equity for this project is closest to: A) $94,100 B) $90,000 C) $86,250 D) $98,600 Answer: B Explanation: A) B) (.5)$90, 000 + (.5)$117, 000 PV(equity cash flows) = = $90,000 1.15 C) D)
2) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate, then the value of the firmʹs levered equity from the project is closest to: A) $0 B) $10,000 C) $6,000 D) $8,600 Answer: B Explanation: A) B) (.5)$90, 000 + (.5)$117, 000 PV(equity cash flows) = = $90,000 - $80,000 = $10,000 1.15 C) D)
3) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate, then the cost of capital for the firmʹs levered equity is closest to: A) 45% B) 25% C) 15% D) 95% Answer: D Explanation: A) B) C) D) (.5)$90, 000 + (.5)$117, 000 PV(equity cash flows) = ...