Mett Co. is planning to develop a new product. A year after the launch of the product, it can generate additional cash flows for the company of either £250,000, £110,000, £90,000 or £50,000, with all four scenarios equally likely. The project requires an initial investment of £90,000. The company’s beta is 0.65, its cost of capital is 6%, and the riskfree rate is 3%. Assume perfect capital markets. a) What is the Net Present Value (NPV) of the project? b) Suppose that the project is sold to investors as an all-equity firm to raise funds for the initial investment. The cash flows of the project will be distributed to equity holders in one year. How much money can be raised in this way – that is, what is the initial market value of the unlevered equity? Explain your answer.
Mett Co. is planning to develop a new product. A year after the launch of the product, it
can generate additional cash flows for the company of either £250,000, £110,000,
£90,000 or £50,000, with all four scenarios equally likely. The project requires an initial
investment of £90,000. The company’s beta is 0.65, its cost of capital is 6%, and the riskfree rate is 3%. Assume perfect capital markets.
a) What is the
b) Suppose that the project is sold to investors as an all-equity firm to raise funds for
the initial investment. The cash flows of the project will be distributed to equity
holders in one year. How much money can be raised in this way – that is, what is
the initial market value of the unlevered equity? Explain your answer.
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Can you please answer this part c follow up question:
c) Suppose the initial £90,000 is raised by borrowing at the risk-free interest rate
instead of issuing equity. What are the cash flows to equity and debt holders, and
what is the initial value of the levered equity according to Modigliani and Miller’s
Propositions? Is the company’s
company raise the same amount of capital as before? Explain your reasoning.
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