Suppose the entrepreneur in Slide #174 borrows now $700 when financing the project (the interest rate is 5%, the risk-free rate). According to Modigliani and Miller, what should the value of the equity be? What is the expected return for equity investors?

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An entrepreneur is considering an investment opportunity: - For an initial investment of $800 this year, the project will generate cash flows of either $1,400 or $900 next year, depending on whether the economy is strong or weak, respectively. Both scenarios are equally likely. The project cash flows depend on the overall economy and thus contain market risk. As a result, you demand a 10% risk premium over the current risk-free rate of 5% to invest in this project. - The timeline with the project's cash flow is as follow: Date 0 Date 1 Strong Economy (probability = 0.5) $1,400 -$800 - What is the NPV of this project? Weak Economy (probability = 0.5) $900 An entrepreneur is considering an investment opportunity: - For an initial investment of $800 this year, the project will generate cash flows of either $1,400 or $900 next year, depending on whether the economy is strong or weak, respectively. Both scenarios are equally likely. The project cash flows depend on the overall economy and thus contain market risk. As a result, you demand a 10% risk premium over the current risk-free rate of 5% to invest in this project. - The timeline with the project's cash flow is as follow: Date 0 Date 1 Strong Economy (probability = 0.5) $1,400 -$800 - What is the NPV of this project? Weak Economy (probability = 0.5) $900

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NPV of the project 1400 800 600 600 1 005 01 54545 The NPV of this project is 54545 This is bec... View the full answer