Computation of debt and equity of a firm with market value

Reference no: EM13827119

Problem:

A firm's assets have a market value of $500m; the asset returns have a standard deviation of 25% per year. The firm is financed with zero coupon debt having a face value of $400m and maturing in 5 years. The (continuously compounded) risk free rate is 5%. Suppose the firm now has a potential investment whose cost (internally financed with cash on the balance sheet) will be $80m and have a present value (PV) of $130m. The investment will enable the firm to market a new product and thereby reduce the variability of its earnings, reducing the overall standard deviation of its asset returns to 20%. If the firm undertakes the investment, what would be the new value of its debt and equity? (Assume the investment can be implemented immediately)

Summary of question:

This question basically belongs to Finance as well as it explains about computation of debt and equity of a firm with market value of its assets given and the firm being financed by zero coupon debt.

Reference no: EM13827119

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