The value of a firm's future cash flows is estimated at 230M. The continuouslycompounded risk-free rate is 3%. The duration of firm's debt is 11 years. Theface value of the firm's debt is 280M. The volatility of firm cash flows is 0.22. Thefirm pays no dividends. Use the notion of equity as a call option on the value ofthe firm. Let the firm now accept a project that has an NPV of -10M and increasesthe volatility of the firm to 0.30. What is the new value of the firm's equity?

See the answer in the explanation field.Explanation:Answer information:Step 1:A1BC2Time 113Face…

Answered: The value of a firm's future cash flows…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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You are an investor in the world where short-selling assets is prohibited. Suppose that the price of asset X in period 0 is $200. This asset will pay a dividend of $8 one year from now in period 1. Let the riskless interest rate from 0 to period q be 5%.Assume the price for a future contract delivery in period 1 is $210. a) Can you make an arbitrage profit when $210 is the price? If so, state specifically what financial transaction? b) Now, assume the price for a futures contract with delivery in period 1 is K190. Can you make an arbitrage profit when this is the price? If so, state specifically what financial transaction you would make in 0 and period 1 to realize a profit. If not, explain?
An all-equity firm consists of a single project that will produce a perpetual cash flow of either $100M (good state) or $30M (bad state) next year. The probability of the good state is 30 percent. The beta of the asset cash flows is 1.25 and the risk-free rate is 3 percent and the market risk premium is 8 percent. There are 6M shares outstanding. Suppose the firm announces it will issue $40M in debt. The debt has an interest rate of 8 percent, and will mature in 3 years. Because the debt is ___ , any bankruptcy costs would ___ the firm's share price after the announcement. a. Safe, not change b. risky, raise c. risky, lower
Consider a two-date binomial model. A company has both debt and equity in its capital structure. The value of the company is 100 at Date 0. At Date 1, it is equally like that the value of the company increases by 20% or decreases by 10%. The total promised amount to the debtholders is 100 at Date 1. The riskfree interest rate is 10%. a. What are the possible payoffs to the equityholders at date 1? What kind of financial product has the same payoffs? Please describe the detailed characteristics of the financial product. b. What are the possible payoffs to the bondholders at date 1? Are they riskfree? What kind of financial product/portfolio has the same payoffs? Please describe the detailed characteristics of the financial product/portfolio.
H3. The value of HILEV firm at the end of one year can be $50 m or $100 m with equal probability of 0.5. The firm has debt with a face value of $50 m that matures in one year. Assume that investors are risk-neutral and the risk free rate is zero. The CEO of the firm decides to substitute assets of the firm with more risky assets immediately, so that the value of the firm at the end of one year is either $30 m or $120 m with equal probability of 0.5. This asset substitution will lead to A. A gain of $10 million for stockholders and a loss of $10 million for bondholders B. A loss of $10 million for stockholders and a gain of $10 million for bondholders C. No gain or loss to debtholders or equity holders D. Both debtholders and equity holders will lose $10 million from the increased risk of the business Show proper step by step calculation
Sefton Villa will be worth either €60 million, €80 million or €100 million in one year with equal probabilities. The firm has bonds outstanding with a promised payment of €75 million in one year at an expected rate of 6% and the required rate of return on the assets is 12%. What is the company's equity cost of capital? What is the expected payoff of the debt? What is the debt’s promised rate of return?
A company needs ghc1000 to finance its activities. The firm can finance this expenditure either by bonds or equity. Interest rate on bonds is 10%. The company can earn ghe 160 in good years and ghc80 in bad years. Assuming the firm faces one-quarter probability of good years; What will be the stream of returns on both bonds and equity if the company chooses the following financing options? i. a. 100% equity financing ii. 50% equity financing iii. 20% equity financing iv. 0% equity financing Estimate the equity risk associated with each option in (a) As an investor who wants to purchase a share in the company, which financing option will make you purchase the stock. Why? b. C.
Okik Inc. has a beta coefficient of 1.0 and a required rate of return of 12 percent. The market risk premium is currently 8 percent. If the risk free rate increases by 2 percentage points, and Okik Inc. acquires new assets which increase its beta by 50 percent, what will be Okik’s new required rate of return? Give your answer in whole number, disregard the % sign e.g. 25% should be written as 25.
Your firm has 1,500,000 in stock assets with a duration of 16 and 500,000 in cash with a duration of 0. Your firm has issued a debt with a present value of of 1,800,000 and a duration of 14. The yield curve is flat at 4.50% A. What is the duration of the equity? B. Your firms risk management team is concerned that interest rates will change to 4.85. using duration analysis, how much would you estimate the value of your equity will change if interest rates were to change to 4.85%? C. if you wanted to immunize the value of your firms equity(i.e. set it's duration=0) how much would you need to have invested in cash and how much would you need invested in stock assets in order to achieve this goal?
You are thinking about buying the debt in a private firm that has very similar risk and capital structure as SleazCo. SleazeCo has zero-coupon debt that requires them to pay back $160,000,000 three years from now. Given this loan, the market value of SleazCo’s equity is $25,000,000 and has a volatility of 80% per year. The annual risk-free rate is .02 at all maturities. SleazeCo has no other debt. What are the estimates of the following values for SleazCo based on the Merton Model? Volatility of Assets () = _______________ Value of Assets (V0) = _________________ Market Value of the Debt now = _________________ Value of Debt if it is risk free = _________________ Expected Loss from default = __________________ Probability of default on the debt = _______________ Expected recovery rate on the debt = ______________
a. Consider the following outcomes both for the following scenarios with and without leverage for Moon Industries' new venture. Assume Moon's new venture is equally likely to succeed or to fail. The risk-free rate is 4%. The venture has a beta of 0 and the cost of capital is equal to the risk-free rate. Compute the value of Moon's securities at the beginning of the year with and without leverage. With Leverage Without Leverage Failure Failure $90 $0 $90 Success Success $150 Debt value $250 $250 $90 $90 $100 $250 Equity value Total to all investors b. Now assume that the costs of financial distress is $15 million. Compute the value of Moon's securities at the beginning of the year with and without leverage given that financial distress is costly. Without Leverage Failure With Leverage Success Success Failure Debt value $150 $75 $0 $75 Equity value $250 $90 $100 Total to all investors $250 $90 $250 4.
A firm is considering a new project which would be similar in terms of risk to its existing projed The firm needs a discount rate for evaluation purposes. The firm has enough cash on hand provide the necessary equity financing for the project. Also, the firm has 1,000,000 common shan outstanding with a current market price of GHe11 per share. Next year's dividend is expected be GHc1 per share and the firm estimates dividends will grow at 5% per year for the next sever years. The firm also has 150,000 preferred shares outstanding with a current market price GH¢10 per share. Dividend of GHe0.9 per share is paid on preferred stock. The firm has a total o GH¢10,000,000 in debt outstanding. The debt stock is currently valued at of GH¢9,500,000. Th yield on the debt is 8%. The firm's tax rate is 20%. The project requires an initial capital investmen of GHc500,000. However, the project is expected to generate GH¢100,000 annually in perpetuity. Required: i Calculate the WACC for this project?…
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