A company has its debt structured as a single zero-coupon bond that matures in 5 years. The face value of the debt outstanding is $40 million and the current value of the company's total assets is $36 million. The standard deviation of the return of its assets is 30 percent per year, and the risk-free rate is estimated to be about 5 percent per year, compounded continuously. Suppose this company has a new project opportunity available. This project has an estimated NPV of $3,000,000. If the company undertakes the project, what will be the new market value of equity? Assume volatility is unchanged. Assuming the company decided to undertake the new project and does not borrow any additional funds, what is the new continuously compounded cost of debt? Explain in detail the impact this project has on the cost of debt.

A company has its debt structured as a single zero-coupon bond that matures in 5 years. The face value of the debt outstanding is $40 million and the current value of the company's total assets is $36 million. The standard deviation of the return of its assets is 30 percent per year, and the risk-free rate is estimated to be about 5 percent per year, compounded continuously. Suppose this company has a new project opportunity available. This project has an estimated NPV of $3,000,000. If the company undertakes the project, what will be the new market value of equity? Assume volatility is unchanged. Assuming the company decided to undertake the new project and does not borrow any additional funds, what is the new continuously compounded cost of debt? Explain in detail the impact this project has on the cost of debt.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section: Chapter Questions

Problem 27P

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