A firm is worth $50 or $180 with equal probability and is financed with debt that has a face value of $60. It is considering a new project that is equally likely to be worth -$50 or +$40. The cost of capital is 12% for all securities.
-Refer to the information above. Calculate the present values of the firm's debt and equity if the project is undertaken.

Question

Quizplus · Accepted Answer

The expected value of the firm without the project is $115. The project has an expected value of -$5, so the firm with the project is worth $110. The debt's expected payoff is $60, discounted at 12%, giving a present value of $40.18. The equity is the remainder, $58.03.

A Firm Is Worth $50 or $180 with Equal Probability