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What is the current value of the firms debt and equity

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Question - Xiomara Ltd, a manufacturing company, is considering a significant new investment in a product line that utilizes green technology aimed at households. Xiomara's current manufacturing will stop making revenues shortly, so the new asset is a welcome addition to the balance sheet that can help pay off Xiomara's long-term debt burden.

Xiomara is currently finalizing an investigation into the new product line's earnings potential, estimated to be between £30m and £100m. The research will reveal the true earnings potential, which will be any number between £30m and £100m. The investment cost is £40m, and the firm will not make the investment decision until the firm finalizes its investigation into the earnings potential of the new product line.

The face value of the current long-term debt burden of Xiomara is £20m. The debt is due shortly. and the firm can service only £5m of this liability from the firm's current earnings flow.

For your answer, you should assume that the market is risk-neutral, that the discount rate is zero. and that the earnings potential signal is distributed uniformly between £30m and £100m.

Please answer the following questions:

(a) If the firm had zero long-term debt, what would be the current value of the firm's equity (that is, before the firm finalizes its investigation into the earnings potential)?

(b) What is the current value of the firm's debt and equity?

Reference no: EM133183084

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