Assume a zero percent discount rate for simplicity. Your current projects cost $200, and you know they will return $800 next year. There is a new project that will cost $300 and will return
$500. Your investors believe, however, that both the current projects and the new projects will
Return only 50%. If you have no cash and can use only equity financing, what will the value of
The combined firm be to the existing shareholders if the new project is undertaken?

Question

Quizplus · Accepted Answer

The value of the combined firm to the existing shareholders if the new project is undertaken is $780. This is because the current projects will return $800 next year, and the new project will return $500 next year. The total return from the combined firm will therefore be $1,300. The value of the combined firm to the existing shareholders is equal to the present value of this future return, which is $780.

Assume a Zero Percent Discount Rate for Simplicity