Reference no: EM132715451

Your firm is considering a new investment project that costs $1,000K. There are two states of the world that will determine the values of your existing assets and new investment project. As the manager, assume your objective is to maximize the value to current shareholders. The following table provides you with financial information for your firm in each state of the world (all values are in thousands of $):

Probability of State
State G 50%
State B 50%
Present Value of Existing Assets
State G 8,000
State B 4,000
Cost of New Investment
State B State G 1,000
State B 1,000
Present Value of New Investment
State G 2,500
State B 1,500
NPV of New Investment
State G 1,500
State B 500
Value of Assets with Investment
State G 10,500
State B 5,500

The manager announces that she will invest in the new project. The public does not know the true state of the world, but knows that the manager knows the true state of the world. Suppose first that the manager will raise the $1,000K by issuing equity. In part (a), also assume that the public does not infer the state of the world from the manager's decision to issue equity.

a) What percentage of the firm will these new shareholders demand in exchange for $1,000K? In the next two questions, the NPV of mispricing equals the cash received from selling the equity ($1,000K) minus the value of that equity. The value of the equity that was sold is calculated as the percentage of the firm that was sold multiplied by value of the assets (with the new investment) in that state.

b) What is the APV of the new investment project (NPV of the new investment plus the NPV of mispricing) if the manager knows that the true state of the world is State G?

c) What is the APV of the new investment project (NPV of the new investment plus the NPV of financing) if the manager knows that the true state of the world is State B?