question archive 1) Consider a firm that has non-cash assets that will be worth either $130 in the 'good' state of the world, or $90 in the 'bad' state of the world
1) Consider a firm that has non-cash assets that will be worth either $130 in the 'good' state of the world, or $90 in the 'bad' state of the world
Subject:AccountingPrice: Bought3
1) Consider a firm that has non-cash assets that will be worth either $130 in the 'good' state of the world, or $90 in the 'bad' state of the world. The firm currently has $10 of cash, which may be invested in a new project. The new project will yield either $30 in the good state, or -$35 in the bad state. If the project is not taken, the cash may be invested at 10%, which is the firm's cost of capital. Both economic states are equally likely.
a. Would the entrepreneur accept the new project if the firm was all-equity financed?
b. Would the entrepreneur accept the new project if the firm was partially debt-financed with a bond with face value $90?
4. Consider a firm that has non-cash assets that will be worth $150 in the 'good' state and $70 in the 'bad' state. The firm currently has $10 of cash, which may be invested in a new project. The new project will yield either $5 in the good state, or $50 in the bad state. The firm is financed with a bond promising to pay $120. The firm's cost of capital is 10%. Both economic states are equally likely.
a. Is the new project a positive NPV project?
b. Would the entrepreneur choose to take the new project?
5. Consider a firm that will be worth either $60 or $160 in equally likely states of the world, and assume all investors require a 10% expected return. Finally, assume that, in the event of financial distress or bankruptcy, the firm will lose $10 in deadweight costs. Calculate the change in firm value if the firm issues a bond with face value $94 relative to the firm if all equity financed.
