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Problem - Consider a project with free cash flow in one year of $131,536 or $182,630, with either outcome being equally likely. The initial investment required for the project is $110,000, and the project's cost of capital is 22%. The risk-free interest rate is 10%. (Assume no taxes or distress costs.)
Required -
a. What is the NPV of this project?
b. Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. How much money can be raised in this way-that is, what is the initial market value of the unlevered equity?
c. Suppose the initial $110,000 is instead raised by borrowing at the? risk-free interest rate. What are the cash flows of the levered equity, and what is its initial value according to M&M?
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